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U.S. corporate bond markets have seen record inflows this year as investors scramble to lock in the highest yields in years ahead of an expected series of interest rate cuts by the Federal Reserve.
Flows into corporate bond funds are expected to reach $22.8 billion by 2024, according to fund tracker EPFR, the first positive start since 2019, when they had $22.4 billion in flows at that point.
The trend is pushing up prices and helping to compress so-called spreads, the extra interest paid to the U.S. Treasury by corporate borrowers, to their lowest levels in two years.
Most of the money is going into investment-grade cars, pushing spreads to two-year lows, but some is going into junk bonds, where spreads are at 26-month lows and higher than they were in 2007. This is slightly above the level before the global financial crisis. .
But even with spreads at such low levels, some investors still doubt the health of the world's largest economy and the severity of corporate distress, especially if the Fed doesn't deliver the rate cuts the market expects. We are concerned about the possibility of an increase in debt financing and defaults. .
“There's a risk that this momentum will overheat,” said Christian Hantel, a portfolio manager at Vontobel. “The momentum is so strong that some investors want to get into the market no matter what the price is.”
This could mean that “the risk premium for certain credits is no longer appropriately priced,” he added.
The Fed on Wednesday kept interest rates unchanged at 5.25% to 5.5%, a 22-year high, and reiterated its previous expectation that they would be cut by three-quarters of a percentage point this year. Nevertheless, recent data showing persistent price pressures have some investors worried about the central bank's ability to pull off a so-called soft landing for the economy, bringing down inflation without triggering a recession. I feel it.
“If we are not able to thread this needle, we run the risk of accelerated unemployment,” said Adam Abbas, head of fixed income at Harris Associates. “I think there is credit spread risk here.”
Market volatility over the past two years has led investors to conserve cash or exit bond funds, raising borrowing costs and limiting companies' ability to raise new capital. .
But the Fed's so-called “pivot” in December, the strongest signal yet by a central bank that it was ready to start cutting interest rates, spurred inflows into credit funds. did.
“Investors are shifting significantly away from lower-risk products that have been hidden for some time,” Hantel said.
The money comes from a wide range of retail and institutional investors in the U.S. and abroad, attracted by high yields, fund managers said. The average yield on U.S. investment-grade bonds, which attract about four-fifths of new capital, is now 5.4%, lower than the recent high of 6.4% in 2023 but still below the lowest level since the coronavirus crisis. It's far superior.
“We have attractive real yields and the largest and most liquid credit market, so we attract capital from all channels and all geographies,” said John McClain, portfolio manager at Brandywine Global Investment Management. ”
Borrowers flooded the market again this year. Investment-grade companies alone have issued a record $561 billion in dollar-denominated corporate debt since the beginning of the year, the most since at least 1990, according to LSEG data. Issuance of high-yield corporate bonds has also accelerated, increasing by 64% annually. The year-on-year increase was $62 billion, the highest total in the past three years.
Nevertheless, investor demand is pushing spreads down, with the average spread on investment-grade bonds now at just 0.92 percentage points, down from 1.04 percentage points in late December, according to IceBank data, and expected to rise in 2022. It's the narrowest it's been since January. This year, it has fallen from 3.39 percentage points to 3.14 percentage points, hovering around the harshest level since January 2022.
Andrzej Skiba, head of BlueBay U.S. fixed income at RBC GAM, said the move “shows how investors are afraid of missing out on opportunities to lock in yield.”
While analysts believe that investment-grade issuers are unlikely to default, they believe the quality of issuers in the junk bond market has improved. Hantel said he wasn't too concerned about spread levels yet, but said it was becoming increasingly clear that some new issue trades were “obviously tighter.”
The potential for lower demand and wider spreads in the future means investors will need to: [their] “Don't be last in line to sell bonds,” he added.
