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US junk bond sales resume after Fed snaps summer rally

Risky U.S. corporate borrowers are facing a fresh rise in borrowing costs on concerns that the Federal Reserve’s rate hike will weigh on the world’s largest economic market.

U.S. junk bond yields jumped to nearly 8.6% from 7.4% in mid-August, according to an index from Ice Data Service. The rise reflects a significant decline in bond prices.

The fresh sell-off in high yield comes after a brief summer lull in which the riskiest assets have recovered somewhat from the dismal first half of 2022. Peace has been shattered by stepping up the fight against inflation.

“As this summer of optimism draws to a close, fears of the Fed’s direction and recession are coming to the fore,” said Morgan Stanley strategist Srikanth Sankaran.

As a result, investors raced for funds to buy junk-rated US corporate bonds, withdrawing $8.7 billion from their accounts in the past two weeks, according to flows tracked by EPFR. Last week’s redemptions ranked as the sixth-largest weekly outflow since the coronavirus pandemic rocked US financial markets in 2020.

Worst-case yields (%) line chart showing US junk bond yields rising

Goldman Sachs strategist Lotfi Karrui said in a speech delivered by Chairman Jay Powell at the Jackson Hole Economic Summit in late August that the Fed chairman should tighten central bank monetary policy to combat inflation. He surprised investors by stating that he vowed to “continue”.

“Powell’s annual speech . “For the market, this means a return to square one as investors recalibrate their expectations of growth, inflation and the policy mix, which could remain unfriendly for quite some time. is high,” he said.

The rise in junk bond yields reflects rising expectations of rate hikes that have impacted the broader U.S. bond market and growing concerns about the ability of lower-rated companies to meet their obligations. Traders now expect the Fed to lift rates from his current 2.25-2.5% to near 4% by early next year.

A vertical bar chart of weekly flows into US High Yield Corporate Bond Funds ($B Billion) shows that junk bond funds have redeemed for two consecutive weeks.

The yield spread between US junk bonds and ultra-low-risk US government bonds surged to just over 5 points from 4.2 points in mid-August. It started the year with about 3 percentage points. Ed Smith, co-chief investment officer at Rathbone Investment Management, said widening spreads “suggest a worsening growth outlook and an increased likelihood of a recession.”

But Morgan Stanley’s Sankaran notes that while current levels point to a more “tense market,” it needs to go much higher to fully price in the risk of a recession.

Many businesses are taking advantage of the period of historically low interest rates after the COVID-19 crisis to reduce their borrowing costs and delay the maturity of the original loan amount, leading to an increase in default rates. generally remains at a low level.

A line chart of US high yield spreads (percentage points) shows that rising spreads make the market more concerned about credit risk

But cracks are beginning to appear. There were default events affecting $4.7 billion worth of bonds and loans in the U.S. market in August, the third highest total since November 2020, according to data from JPMorgan Chase. , noted that August marked the sixth straight month of default activity above $3.3 billion, compared to a monthly average of $1.3 billion from November 2020 to February 2022.

Sankaran said the second-quarter earnings season, which provided the latest snapshot of U.S. corporate fundamentals, was “not overwhelmingly negative . . . There was abundant evidence of inventory pressure.”

The sale comes at a bad time for Wall Street’s major banks, which are expected to begin pitching tens of billions of dollars worth of bond sales to investors next week. The money manager plans to launch his $15 billion financing package bank led by Bank of America to fund his $16.5 billion acquisition of software firm Citrix by Vista Equity Partners and Elliott Management. I pay particular attention to being

The bank is eyeing losses that could exceed $1 billion on the deal and is seen as a harbinger of terms lenders will demand for new junk bonds.

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