“Perfect prices” are faltering as debt markets falter

(Bloomberg) — Credit investors got a glimpse of economic and geopolitical reality this week as hawkish comments from central bank officials on borrowing costs and tensions in the Middle East sent debt markets into turmoil.

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The decline was sparked in part by comments from Federal Reserve Bank of New York President John Williams, who said there was no rush to cut interest rates and it was possible that economic data could even justify an increase if inflation continues.

The realization that the rate turnaround is yet to come comes as the U.S. economy continues its strong performance, leading to easing of financial conditions in recent months. As a result, there is no market sign yet that the central bank has tightened its monetary policy enough to begin easing, said Bill Zox, portfolio manager at Brandywine Global Investment Management.

The return of the higher-for-longer mantra is a headache for insurance companies and pension funds, which have seen a flood of liquidity send demand for bonds soaring this year as they sought to protect yields ahead of expected cuts. Companies responded by issuing more than $1 trillion of debt globally so far this year, the second-highest level since at least 2013. But now investors are pulling money out of high-yield funds and inflows into higher-quality, shorter-dated products have slowed slows down dramatically.

Click here to listen to a podcast about how Morgan Stanley believes credit ratings could get into trouble if the Fed raises interest rates.

US investment grade credit spreads are only widening slightly and demand for many new issues remains strong. However, there are clear signs of growing caution in credit markets: spreads on US junk debt have widened following the rise in negative sentiment, and high-yield bonds are poised for their biggest monthly loss on a total return basis since September 2022. It is a Significant turnaround from the feeling of complacency that a Bank of America Corp. survey found. Among fund managers earlier this month, global perceptions of credit risk hit their lowest level since February last year.

Adding to the problems for policymakers, retaliatory strikes between Israel and Iran have pushed up oil prices, which could fuel inflation. Tensions in the Middle East also threaten to dampen demand for loans as investors instead seek havens such as government bonds.

The story goes on

Investor pushback

One area where investors shy away is the leveraged loan market. Although demand remains, asset managers have successfully pushed back on the terms demanded by issuers in recent days.

Rocket Software Inc. was forced in recent days to abandon plans for a sustainable debt structure due to feedback from asset managers, according to people familiar with the matter. If this trend continues, it may be positive for private lenders, which have once again faced competition from banks in recent months.

In Europe it's a different story. Traders expect about 80 basis points of interest rate cuts from the European Central Bank this year, and officials have stressed that they still plan to cut rates first in June and do not need to wait for the Fed.

Still, this week's volatility means more than 70% of bond trades issued in Europe were in the red in London on Friday morning, hurting retail investors, data compiled by Bloomberg News show.

Back in the US, some junk companies are at risk of being hurt by tightening monetary policy.

“If these cuts are enforced after the election, that could be a challenge for some of the lower quality floating rate issuers,” said Meghan Robson, head of U.S. credit strategy at BNP Paribas, in an April 10 interview with the Credit Edge Podcast. “This risk is not yet priced in, but could enter into the debate as we approach the June and July schedule.”

Weekly review

• Banks including JPMorgan Chase & Co., Wells Fargo & Co. and Goldman Sachs sold bonds in the U.S. prime bond market this week after reporting first-quarter results.

  • Wells Fargo & Co. sold $4.25 billion in debt on Monday and 1.25 billion Canadian dollars ($900 million) in the Canadian bond market on Tuesday, while Morgan Stanley sold $8 worth of bonds on Wednesday Billion dollars sold after the company reported better-than-expected quarterly sales.

• Banks are fighting back as private lenders capture ever larger slices of the lucrative business of financing leveraged buyouts: They act as intermediaries in transactions between smaller companies seeking loans and private lenders willing to provide financing.

• Wall Street's securitization engine is revving up and issuance is hitting record levels as borrowers rush to secure financing ahead of credit market disruptions caused by the U.S. general election.

• The U.S. leveraged loan market, still unfazed by the shift to longer-term higher interest rate policies, may soon join the woes of other asset classes.

• Fading hopes that the Federal Reserve will soon cut interest rates are prompting U.S. banks to reassess the cost of their preferred shares, potentially leading to a flood of deals for the crucial source of capital.

• Banks are increasingly gathering orders for riskier high-yield bond and leveraged loan sales privately before formally announcing them to the broader market, to ensure the deals find enough demand in tough markets.

• Blackstone Inc. provided a roughly $2 billion financing package to Park Place Technologies to refinance the company's debt and fund a payout to its private equity owners.

• As climate change exacerbates droughts and wildfires, and utilities often take the blame for causing them, their assets are increasingly at risk.

• Riverside Co. is exploring strategic options, including a sale of its direct lending unit, Riverside Credit Solutions.

• Asset manager Columbia Threadneedle Investments believes now is a good time to capture a larger share of the secured loan market and recently announced it plans to expand its CLO business and become a regular issuer.

• Library services companies Baker & Taylor and Media Source Inc. have been in discussions about a merger and have contacted direct lenders about financing the potential deal.

• Bayview Asset Management, an asset manager, is in the process of marketing a complex bond created to help SoFi Technologies Inc., an online bank and lender, secure part of its student loan portfolio.

• Vietnamese companies are reducing new bond issuance as yields rise and the government tightens scrutiny of capital markets, a development that raises concerns about refinancing risk.

On the way

• The head of Toronto-Dominion Bank's private debt division has left the company as part of a restructuring of the Canadian lender that will see 3% of jobs cut worldwide.

• Siemens AG has hired Milan Senicic as an executive director to lead its corporate and leveraged finance business in Australia.

• ING appointed Gautam Saxena as head of corporate finance for Asia Pacific.

– With assistance from Michael Msika, Jill R. Shah, Paul Cohen and Dan Wilchins.

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