When asked to identify “the most likely reason” for a prospective pause in the Fed’s tightening cycle, around 10% of investors who responded to the June installment of BofA’s Global Fund Manager said high yield bond spreads rising back above 500bps.
That isn’t going to be sufficient. Unless you believe the Fed is set to pause its hiking cycle imminently.
Junk spreads breached those levels during Thursday’s selloff, when they widened more than 30bps (figure below).
It’d be too strong to say the Fed doesn’t care about such things. 100bps worth of widening in just two weeks counts as rapid. But at the current juncture, this is a secondary concern for policymakers. Their primary concern is, obviously, inflation.
Speaking of “primary” concerns, junk issuance has evaporated. YTD volume is just $67 billion.
As the figure (below) shows, the drop-off versus the last two years is dramatic.
That speaks both to challenging market conditions and the removal of the Fed doorstop. Jerome Powell’s support for corporate credit in the wake of the pandemic facilitated an epic debt binge on the part of high yield and IG borrowers. Investors were receptive, to put it mildly.
“The Fed is now squarely focused on inflation and seems ready to take collateral risk,” Barclays’ Brad Rogoff said, adding that although the Fed’s prioritization of the inflation fight at the possible expense of the economy “worsens the downside scenario,” the bank nevertheless believes IG and HY will trade, at worst, near current levels by year’s end.
Note that outflows are egregious. That’s not hyperbole. IG funds bled $8.7 billion last week on Lipper’s data (figure below). It was the largest outflow since the mass exodus that accompanied the original COVID panic and the third largest on record.
IG funds have now seen a dozen weeks of outflows, the longest such streak in history.
High yield funds, meanwhile, shed almost $6 billion over the week. That was the most since the implosion of the VIX ETN complex in February of 2018, Powell’s first month in the big seat.
But blue chip companies don’t appear to be having much trouble courting investors. High-grade borrowers have tapped the market for almost $700 billion so far in 2022 (figure below).
Note that IG issuance from January 2021 through the end of May 2021 was around $685 billion. So, high-grade volumes are essentially on par (no pun intended) with last year, despite some of the worst returns in history.
That said, caution abounds. “A high-grade supply backlog is beginning to grow after at least six issuers are said to have stood down over the past couple of days,” Bloomberg’s Jack Pitcher noted on Thursday, when risk assets were beset.
The IG primary market was quiet this week. And by that, I mean volume was zero. “[This] is effectively the second time in the past month when we have gotten no supply in an entire week,” BMO’s Daniel Krieter and Daniel Belton remarked, calling that “another poor harbinger for the path of credit in the near-term.”
