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U.S. corporate bond spreads widen as investors de-risk on hawkish Fed

Randy Mancini 8 Jan 28
FILE PHOTO: Traders work on the floor of the NYSE in New York
FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., January 25, 2022. REUTERS/Brendan McDermid/File Photo

January 28, 2022

By Davide Barbuscia

NEW YORK (Reuters) – Investors sold U.S. corporate high-yield and investment-grade bonds on Friday, moving in step with weakness in equity markets and in a sign of risk aversion amid worries about a series of interest rate hikes.

The Markit North American High-Yield CDX Index, which tracks the cost to insure high-yield corporate debt and is a proxy for the junk market, fell in price to a low of 105.947%, the lowest since Nov. 2020, as investors sold the contract betting on credit deterioration.

That was down around 1 percentage point from Wednesday, when the U.S. Federal Reserve hinted at multiple interest rate increases this year.

Spreads on Markit’s North American Investment Grade CDX Index rose to 62.5 basis points, hitting their highest since Nov. 2020, as investors hedged bets on a deterioration in credit quality.

Investors pulled out of U.S. corporate bonds in tandem with weakness across the U.S. major stock indexes after the Fed signalled in a policy update this week that an interest rate hike could be coming soon and that it would push forward with policy tightening measures to fight unabated inflation.

“People are expecting a bunch of rate hikes, they’re expecting the (Fed) balance sheet runoff to be faster and sooner than people had expected even a couple months ago”, said Ryan O’Malley, a fixed income portfolio manager at Sage Advisory in Austin, Texas.

Spreads, which refer to the interest rate premium investors demand to hold corporate debt over safer U.S. Treasury bonds, narrowed last year as government debt yields dropped, driving money into securities with lower credit ratings than Treasuries.

“Money has been pushed out to the far ends of the risk spectrum, because you couldn’t get anything out of the front end in Treasuries or investment grade … Now that the tide is kind of going back out, people don’t want to own the riskier stuff anymore”, said O’Malley.

The yield spread on the ICE BofA U.S. High Yield Index, a commonly used benchmark for the junk bond market, rose to 346 basis points on Thursday from 325 bps on Wednesday, after the Fed update.

Still, while rising spreads are consistent with a decline in risk appetite, some investors expect them to only rise a little due to a still strong economic background.

“I don’t think spreads should widen in the corporate sector … corporates are in strong financial positions, they have benefited from two years of easy money,” said Jack McIntyre, a portfolio manager at Brandywine Global.

For research firm Capital Economics, unless equity market weakness triggers a broader loss of investor confidence, spreads are likely to rise only marginally in the next few years.

“This is underpinned by our view that, while global economic growth will slow, the economic backdrop is still likely to be fairly positive; we are not anticipating anything that would significantly challenge firms’ ability, in general, to service their debts,” it said in a report on Friday.

(Reporting by Davide Barbuscia; Editing by Alden Bentley and Nick Zieminski)