The Federal Reserve has shown that it knows how to maintain the flow of credit during a crisis.
But bond investors now also expect the Fed’s unprecedented stimulus in financial markets to change the course of the credit cycle – that is, preventing more companies from falling than expected just a few months ago.
“It is a key axiom that companies do not stop paying because they are losing money,” said Steven Oh, head of global credit and fixed-income leverage at PineBridge Investments in Los Angeles, in an interview with MarketWatch. “Businesses stop paying because their access to liquidity is depleting.”
Hertz Global Holding Inc. HTZ,
JC Penney Co. Inc. JCP
and Frontier Communications Corp.
FTRCQ,
They are among the deluge of US companies that no longer paid a combined high-yield debt of $ 52.6 billion this year, according to B. de A. Global.
To help prevent credit from freezing during the first rounds of city and business tax closings during the pandemic, the Federal Reserve, for the first time in history, began buying US corporate debt, initially in May through negotiated funds on the stock market and one month later through the direct purchase of individual bonds.
The Fed promised not to run “like an elephant” through the corporate bond market, and its latest count shows it has about $ 44 billion of $ 750 billion in funds earmarked for the sector. Still, the collateral effects of his stimulus efforts have been dramatic. The recovery has traversed the equity and debt markets, despite alarming new rates of coronavirus infections in parts of the US, including California, Florida and Texas.
US stock indices closed lower on Friday as US-China relations weakened and policy makers in Washington discussed the upcoming pandemic stimulus package, but the S&P 500 SPX index,
it ended 0.5% away from recouping all its losses in the year to date, while the DIA Jones Industrial Average DJIA,
ended 7.3% of a similar recovery.
The iShares iBoxx $ Investment Grade Corporate Bond ETF LQD,
the largest of its kind, ended Friday’s session 0.2% lower, but 7.9% higher in the year to date. The rest of the debt markets have also recovered, underscored by the decrease in credit spreads, or the level of compensation investors receive for a bond, above a risk-free benchmark such as Treasurys TMUBMUSD10Y,
In addition, this week’s high-yield bond spreads touched a new post-COVID low of 528 basis points on US Treasuries, according to B. de A. Global data, despite annual $ deluge 228 billion new issues. Similarly, investment grade spreads fell this week to a record low of 243 basis points above the same benchmark, according to JPMorgan data, even with a record issuance of $ 1.3 trillion.
That means investors are being paid much less to buy corporate bonds than just a few months ago, despite the fact that American companies have been borrowing at a record rate and even though the pace of economic recovery from the US pandemic remains uncertain.
Meanwhile, the central bank’s balance sheet now stands at just under $ 7 trillion from about $ 4.2 trillion in March, primarily due to its unlimited government-backed debt bond purchase program during the pandemic.
“The point is that the Fed backed down on risk appetite,” Jack Janasiewicz, portfolio manager at Natixis Advisors, said in a webinar on Thursday, where he estimated that so far only around 10% of total capacity has been tapped. from the Fed.
“The money returned directly to the credit markets. Mission accomplished by the Fed, ”he said.
Read: Why is the Fed indebted to Tom Sawyer?
Importantly, the potion of high-yield bonds now trading at distressed levels has also dipped to about 18% from 41% during the worst pandemic sales in March, according to JPMorgan data. Conventionally, high-yield or “junk” bonds are considered distressed and more likely to default, once they are traded on spreads of more than 1,000 basis points over a risk-free benchmark, such as US Treasury bonds. the United States.
Additionally, analysts at B. de A. Global looking at a set of high-yield credit stress indicators now see that roughly half implies that the peak default phase of this cycle may have already ended.
“There is increasing evidence that this cycle may be unique not only in the way it started but also in the way it ended,” the team led by Oleg Melentyev wrote in a customer note on Friday.
Credit rating firm Moody’s Investors Service also said this week that it expects the current default rate of 7.3% for speculative-grade US companies to reach 10.5% over the next year, which is below Goldman’s 13% forecast. Sachs for this year.
“Whether you think it is right or wrong, the technical conditions spearheaded by the Fed, not only because of the direct purchase of corporate debt, but also because of its liquidity support for Treasury markets and other markets in general, are going resulting in investor demand shifts to riskier asset classes, ”said Oh.
“We will see reasonably high default rates for this year,” he added. “But our default expectations of two months ago are substantially lower today.”
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