Debt markets priced toward perfection risk stumbling

(Bloomberg) — Cash-rich investors are borrowing and moving up the risk curve to lock in high returns before the Federal Reserve finally starts cutting interest rates.

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According to Bank of America Corp. Money is flowing back into junk bonds and high-grade funds just posted their largest weekly inflow since September 2020. That's 19 consecutive weeks in which investment-grade products have seen a net inflow of money, strategists Michael Hartnett wrote in a note.

The wave of new cash means bond managers say a U-turn on interest rate cuts from the Federal Reserve would be needed to turn sentiment negative. Even if they are not entirely satisfied with the rewards for risk-taking at the moment, there is no choice but to trust that a shift away from money funds and towards debt could cause spreads to tighten even further.

Read more: Credit markets are behaving as if the era of easy money never ended

“Price movements are typical of the end of the bull market in credit markets,” said Jose Mosquera, chief investment officer of Madrid-based hedge fund Quadriga Rho Investments Multi-Strategy, referring to pricing in Europe. “Investors are moving further down the credit spectrum and toward less common borrowers.”

Here are five charts that show what's happening in debt markets:

Fed risk

The biggest risk to credit right now is “the Fed and all the other central banks completely reversing the rate cuts that they've already announced to us,” said Richard Hodges, who manages the global dynamic bond fund at Nomura Asset Management. Traders have scaled back their expectations of interest rate cuts by the Federal Reserve this year as further U.S. data releases show the economy's continued resilience. While Chairman Jerome Powell suggested Thursday that the central bank is nearing the confidence it needs to begin cutting interest rates, the pace and extent remain uncertain.

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New money

Inflows into investment-grade bonds are entering the year at their highest level since just before the pandemic, helping to tighten spreads. A small shift from money market funds, which currently hold more than $6 trillion, to credit would make it even tighter, according to Hodges.

“You just need a smaller percentage to get out and that will be enough as people are worried about missing out on the returns on the bonds,” he said, adding: “Because of the weight, spreads can probably get tighter than you think.” would ever imagine.” how much money is invested.

Credit risk appetite

Sales of subordinated debt from peripheral European countries this week were clear evidence that returns are possible. Investors placed orders worth more than three times the 250 million euros ($272 million) in Tier 2 junk-rated bonds issued by Portugal's Banco Montepio. The securities returned more than 8.5%, nearly double the average return of bonds included in a Bloomberg index that tracks such bonds. Italian lender Banca Popolare di Sondrio received orders worth more than five times the amount offered in a similar sale, according to experts.

Junk spreads are narrowing

The extra yield offered to buy junk-rated bonds has fallen in recent weeks to some of its lowest levels since early 2022, before Russia invaded Ukraine and before the Fed and European Central Bank began raising interest rates . Yields on the riskiest part of the market, CCCs, fell below 12% in the US this week for the first time this year.

Shrinking need

Even distressed debt is benefiting from the broad-based recovery: Global stocks of distressed corporate bonds and loans have fallen by more than 7% since the beginning of January. In the US, it fell almost 10% to under $198 billion over the same period.

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Weekly review

• Bond investors have punished banks with heavy exposure to commercial real estate, potentially putting even more pressure on lenders' profits as Wall Street struggles to assess how far the burden of real estate debt will spread through the financial system.

• DE Shaw is among hedge funds buying exposure to so-called blind risk pools sold by banks to reduce their regulatory burdens.

• A banking group led by Morgan Stanley has been in talks with Elon Musk and his team about refinancing a roughly $12.5 billion debt package that supported the tech billionaire's acquisition of social media platform X.

• Wall Street bankers seeking new funding for multi-billion dollar acquisitions are getting a boost from a key part of the leveraged loan universe since a record start to the year.

• A group of banks led by JPMorgan Chase & Co. launched a $4 billion leveraged loan sale to acquire Truist Financial Corp.'s insurance business. to be supported by Stone Point Capital and Clayton Dubilier & Rice.

• The artificial intelligence hype has revived a market oddity that many had thought dead with the rise in global interest rates: Investors are once again paying for the privilege of owning certain bonds.

• Local government financing vehicles in China will find it much harder to issue bonds as authorities step up efforts to contain the debt-laden sector's risks in a slowing economy.

• According to Axel Potthof, senior portfolio manager at Fisch Asset Management, European high-yield bonds are currently more attractive in terms of valuation than their US counterparts.

• David Roberts, a bond market veteran who has built several billion-dollar funds from nothing over the past 27 years, is shortening his retirement and buying debt again. His approach is: “No AT1s. No CCCs.”

• Ardonagh Group Ltd.'s $3.3 billion loan Up to 24 lenders were involved, including the most common in such a personal loan transaction. This shows that the size of syndications is increasing as more players want to enter a hot market.

• BlackRock Inc. predicts rapid growth in deals that allow banks to reduce risk in their loan portfolios as stricter capital rules come into effect.

On the way

• Goldman Sachs Group Inc. named banker Jonathan Fine to head its global investment-grade debt business, one of three appointments within the Wall Street firm's financing group.

• US Bancorp named Bill Mulvihill as head of the company's credit capital markets division, succeeding Jeff Stuart, who is retiring after 15 years with the company.

• Lloyds Banking Group Plc said it has appointed Hayley Basterfield as managing director and global head of bond syndicate and liability management.

• Mediolanum International Funds Limited has hired Daniel Loughney as Head of Fixed Income, replacing Charles Diebel.

• Banco Santander SA has hired Credit Suisse's Italian head of investment banking and capital markets, Michele Pangrazzi, as head of industrials in Europe.

• Mizuho Financial Group Inc. has appointed Andrei Irimia to work on the Debt Syndicate Desk for Financial Institutions and EMEA Liability Management.

– With support from Abhinav Ramnarayan, Olivia Raimonde, Michael Msika and Alice Gledhill.

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