Can the Fed tame an avalanche of business distress? Bond investors bet on it


The Federal Reserve has proven that it knows how to maintain credit during a crisis.

But bond investors now also expect the Fed’s unprecedented financial market stimulus to turn the tide of the credit cycle, including preventing more companies from downgrading than just expected. some months.

“It’s a key axiom that companies don’t default because they lose money,” said Steven Oh, global head of fixed income credit and leverage at PineBridge Investments in Los Angeles. , in an interview with MarketWatch. “Businesses default because their access to cash is drying up.” Hertz Global Holding Inc. HTZ,
JC Penney Co. Inc. JCP,
and Frontier Communications Corp.
are part of a deluge of American companies that have already defaulted on a total of $ 52.6 billion in high yield debt this year, according to A. Global’s B.
To prevent credit from freezing in the first rounds of closures imposed on cities and businesses during the pandemic, the Federal Reserve, for the first time in its history, began buying US corporate debt, initially in May. via exchange traded funds and a month later. through the outright purchase of individual bonds.
The Fed has pledged not to run “like an elephant” in the corporate bond market, and its latest tally shows it holds about $ 44 billion of the $ 750 billion in funding allocated to the sector. Even so, the ripple effects of his stimulus efforts have been dramatic. The rebound has spilled over into equity and debt markets, despite new and alarming rates of coronavirus infections in parts of the United States, including California, Florida and Texas.
U.S. stock indices closed lower on Friday as U.S.-China relations frayed and policymakers in Washington scrambled over the next pandemic stimulus package, but the S&P 500 SPX index,
finished 0.5% of recouping all of its losses for the year to date, while the Dow Jones Industrial Average DJIA,
finished 7.3% of a similar rally.
Le FNB iShares iBoxx $ Investment Grade Corporate Bond ETF LQD,
the largest of its kind, ended Friday’s session down 0.2%, but up 7.9% from a year earlier. The rest of the debt markets also recovered, underlined by the narrowing of credit spreads, or by the level of investor compensation for a bond, above a risk-free benchmark like Treasurys TMUBMUSD10Y,

Additionally, this week, high-yield bond spreads touched a new post-COVID low of 528 basis points against US Treasuries, according to B. of A. Global data, despite flooding 228 bps. billion dollars in new issues of the year. Likewise, good-quality spreads plunged this week to an all-time low of 243 basis points against the same benchmark, per JPMorgan data, even with a record issuance of $ 1.3 trillion.
This means investors are paid much less to buy corporate bonds than just a few months ago, even though US companies have borrowed at an all-time high and the pace of the US economic recovery from the pandemic remains. uncertain.
Meanwhile, the central bank’s balance sheet now stands at just under $ 7 trillion, down from around $ 4.2 trillion in March, mostly due to its unlimited debt-backed bond purchase program. to the US government during the pandemic.
“The point is, the Fed has supported risk appetite,” said Jack Janasiewicz, portfolio manager at Natixis Advisors, in a webinar Thursday, where he estimated that only around 10% of the total capacity of the Fed has been operating so far.
“The money went straight back to the credit markets. Mission accomplished by the Fed, ”he said.
Lis: Why the Fed owes Tom Sawyer a Debt
Importantly, the potion of high yield bonds that are now trading at distressed levels also fell to around 18%, from 41% during the worst pandemic sales in March, according to data from JPMorgan. By convention, high yield or “junk” bonds are considered distressed and more likely to default, once they trade at deviations of more than 1,000 basis points from a benchmark without. risk, like US Treasuries.
Additionally, B. of A. Global analysts looking at a set of high yield credit crunch indicators now see about half of the data indicating that the peak default phase of this cycle may already be finished.
“The body of evidence is growing that this cycle may be unique not only in how it started but also in how it ended,” the team led by Oleg Melentyev wrote in a client 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 U.S. firms to reach 10.5% during the year. next year, which is lower than the 13% forecast by Goldman Sachs for this year.
“Whether you think it’s the right thing or the wrong thing, the technical conditions put in place by the Fed – not only because of the direct purchase of corporate debt, but also its liquidity support in the Treasury markets and other markets in general – investor demand is shifting to riskier asset classes, ”Oh said.
“We will see reasonably high default rates for this year,” he added. “But our defect expectations from two months ago are significantly lower today.”


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