Analysis – US credit ‘relief’ rally could be short-lived as Fed interest rate risk looms

© . FILE PHOTO: Jerome Powell, chairman of the board of directors of the US Federal Reserve, speaks during his reappointment to the Senate Committee on Banking, Housing and Urban Affairs on Capitol Hill, in Washington, US, Jan. 11, 2022. Brendan Smialowski/Pool via REUTERS By Davide Barbuscia NEW YORK () – U.S. credit markets got some respite after the Federal Reserve raised interest rates last week, but the relief is expected to be short-lived as uncertainty over the U.S. central bank’s ability to deliver a ​to achieve a soft landing for the economy continues to increase. weigh on risky assets. Corporate bonds got off to a shaky start to the year as concerns that tighter monetary policy could dent corporate earnings and raise borrowing costs made investors more cautious. But after the Fed hiked interest rates by a quarter of a percentage point last week, there was some buying activity in corporate credit, which was in line with a stock rally driven in part by investors comforted by greater clarity about rate hikes and the Fed’s bold action against rising inflation. The yield spread on the ICE (NYSE:) BofA US High Yield Index, a widely used benchmark for junk bond demand, had widened to 421 basis points on March 15 – the highest since December 2020 – from 305 basis points at the start of the year, when investors withdrew from the market. Those yields fell 25 basis points on March 16, as the Fed raised rates for the first time in three years and set an aggressive path for hikes for the remainder of the year. Yields have since fallen further, standing at 367 basis points on Thursday. Similarly, the yield on the ICE BofA US corporate index, which tracks dollar-denominated investment-grade corporate bonds, fell from 152 basis points – the highest since July 2020 – to 146 basis points. It fell further this week to 132 basis points. “Credit spreads have generally risen in sympathy with risky assets more broadly after the Fed,” said Lauren Wagandt, a US investment-grade fixed income portfolio manager at T. Rowe Price. “After the Fed, we have seen yield-based buyers step in as corporate returns have risen and volatility has eased.” Spreads refer to the interest premium that investors charge to hold corporate debt relative to safer US Treasuries. They narrowed last year as government bond yields fell, causing money to flow into securities with a lower credit rating than government bonds. Fed Chair Jerome Powell said Monday that the central bank must act quickly to curb rising inflation and could use more-than-usual rate hikes if necessary, triggering a sharp sell-off in government bonds. Despite the credit rally, investors say uncertainty about the Fed’s ability to cut inflation without triggering a recession is an underlying risk. “We believe the rally was more of a relief rally and will be short-lived as the same risks remain,” Wagandt said. That is already starting to show. BlackRock’s iShares iBoxx $High Yield Corporate Bond ETF – an exchange-traded fund that tracks the US junk bond market – was up 1.4% on March 16, trading at $81.7 per share, but has lost momentum this week. The equivalent of investment-grade corporate bonds has also lost some momentum, falling 1.3% from last week to trade at $120.22 a share on Thursday. Neil Sutherland, portfolio manager at Schroders (LON:), said corporate spreads had widened to a point that, without a recession, could be a good buying opportunity, especially for foreign investors. “Maybe you have a window where spreads will do well in the coming months… most importantly, can the US economy avoid a recession in the face of an aggressive Fed? I think the jury is still out on that.” , he said. †

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