Stop The Presses, An Outflow Was Spotted In IG

Stop the presses.

For the first time since November, investment grade credit funds suffered an outflow, according to Lipper’s data.

Suffice to say that post-pandemic, this is a “rarely seen in the wild”-type of event. The never-ending streak of inflows was desensitizing. But over the week ending July 21, IG credit funds shed $1.198 billion (figure below).

I assume the vast majority of readers are familiar with the backstory, but just in case, I’ll briefly recapitulate.

The Fed’s decision to backstop US corporate credit (announced in late March of 2020) was initially aimed at ensuring corporates weren’t shut out of capital markets as the economy imploded. Not surprisingly, it quickly morphed into a rally catalyst as investors moved to front-run Fed-buying.

The ensuing investor demand, a reinvigorated hunt for yield as risk-free rates plunged and the Fed’s unprecedented guarantee for debt issued by corporate America, together inspired a borrowing binge of epic proportions (updated figure below).

Contrary to what you might be inclined to believe if your source of market information is various Cassandras muttering monotonous moral hazard warnings, the Fed didn’t actually end up buying very much corporate debt, although admittedly, that depends on your definition of “much.” The idea was that the mere prospect of Fed-buying would be enough to support the market. That turned out to be true. And then some.

Now, though, with spreads at or near pre-GFC tights, there are questions as to how much more can possibly be squeezed. Already in Q1 investors were burned by duration-linked trades, but there are risks on both sides. “We continue to believe that sustained inflation is the largest threat to credit spreads, particularly the type of inflation we have seen in the past few months driven by supply-side factors,” BMO’s Daniel Krieter and Daniel Belton wrote Thursday. In other words, margins could be at risk if the consumer isn’t strong enough to absorb higher costs as corporates attempt to pass along input price inflation. Krieter and Belton went on to say that while an abatement of inflation would likely benefit credit in the short-term, especially if “a renewed focus on global growth result[s] in a yield grab mentality,” slow growth can also lead to wider spreads.

That’s just some color to help contextualize things. Speaking of context, the figure (below) gives you a sense of just how bad things were in March of 2020 — it’s a reminder of why the Fed felt the need to intervene.

At the height of the panic, IG fund outflows were over $35 billion for two weeks in a row. Consider that when you hear folks carrying on about “moral hazard.” IG funds bled nearly $110 billion in the six weeks ended April 8, 2020. It wasn’t until August 8 of last year that those outflows were fully recouped.

In any case, the point Friday was just to highlight an exceedingly rare IG outflow. You can probably blame Delta variant concerns and the fleeting market tremors that culminated in Monday’s risk-off trade.

One final figure (below) shows the net weekly outflow (i.e., IG and HY combined) was the second-largest of 2021.


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4 thoughts on “Stop The Presses, An Outflow Was Spotted In IG

  1. High yield real rates are now negative. In looking for an empirical proof of moral hazard, this is a good candidate. It doesn’t seem to matter to investors how much QE is (illegally) directed at corporate securities, the implicit guarantee has been enough to train them.

      1. Dr. H, I am not a lawyer. And legality is only oblique to the thrust of my comment, which is mostly about moral hazard, implicit government guarantees, and the ludicrousness of “high yield” corporate debt yielding negative real rates. I pay no mind to the attention seekers you mention.

        I see little point focusing on issues of legality at this point, given the general lawless and unaccountable context of the present day. However, for the record, I think a reasonable person could interpret that the FED has overstepped its emergency authority under 13(3). “Unusual and exigent circumstances” have, one could argue, come to be normalized. It is not crazy to think the spirit of the laws have been violated, as the domestic banking authority has mission creeped as far as it has into these areas. It is also not crazy, when high yield debt of zombie companies yields negative real rates, to think that the FED will eventually mission creep further into owning equities. You have said as much yourself. And from all appearances, much of the market seems to believe this as well.

        It’s the same type of logic on display as the war on terror. Emergency measures become permanent and normalized, and every crisis begets even larger emergency measures. “Crisis” is contextualized as normal, and words gradually lose meaning.

        It would be nice to see some protracted Supreme Court cases on how the 4th Amendment has been trampled on over the past 20 years, as well as some cases related to the FED, but I am not holding my breath.

        1. “The ludicrousness of ‘high yield’ corporate debt yielding negative real rates…”

          Then don’t buy any. Problem solved… on your end, anyway, which is the only end that should matter to you.

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