Meet the Remnants of the Fed Pivot Party
Riskier companies, which carry about $500 billion in debt, are being left out of the Fed pivot party, according to BofA Global.
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U.S. companies enjoyed a record borrowing spree in January as financial markets rose in anticipation of a rate cut from the Federal Reserve, according to BofA Global. Except for some notable “forgotten” issuers.
A record $174.1 billion in investment-grade corporate bond supply has already been issued this month, with another $1.25 billion expected to be liquidated on Friday, according to Informa Global Markets.
The surge in supply surpassed the previous record of $174.1 billion set in January 2017, according to Informa. Additionally, supply expectations have plummeted since early January.
see: Ford and Toyota ramped up corporate bond borrowing worth up to $60 billion in January as investors looked for interest rate cuts.
“The Fed’s ‘hard pivot’ on the possibility of a rate cut has fueled optimism that the worst impact of tighter monetary policy is behind us,” Oleg Melentiev, credit strategist at BofA Global, said Friday.
But Melentiev said the bottom 30% of companies that rely on high-yield, or junk bond, markets for funding still have “limited access, with recent trading volumes only a quarter of the rate of the top 70%.”
He anchored the world of “forgotten” issuers who owe about $500 billion in high-yield debt, a category that includes loans and bonds. “Even if you have access, the average coupon here is over 11%, or +300 basis points compared to higher quality.”
Just as the stock market’s SPX returned to records from two years ago in January, spreads for investment-grade companies also returned to their lowest levels in nearly two years.
Spreads on the ICE BofA Corporate Index, which tracks investment-grade markets, fell below 100 basis points this week for the first time since January 2022, according to Federal Reserve data.
The spread is the compensation an investor gets for holding a bond above the benchmark Treasury yield to help offset default risk. Lower spreads are a sign of more favorable loan terms for large corporations, governments, landlords and even households.
Zero interest rates return? If you ask your lender, this won’t be the case.
The rally since October has been less specific, especially for riskier companies seen as higher default risks if the Federal Reserve cuts interest rates lower than some in the market expected.
The high-yield corporate bond index, which includes CCC and lower-rated bonds, pegged the spread at 914 basis points, above Treasury yields. This is an increase from about 850 basis points, the lowest in about two years at the end of December.
“We do not believe that all of the group’s $500 billion of debt is at risk of restructuring. In reality, it is likely only a small fraction of that,” Melentyev said, suggesting that a “quick fix” would be for the Fed to cut its policy rate back to zero.
In September 2020, the Federal Reserve projected that its pandemic policy of near-zero interest rates would last until 2023. But that was before inflation continued to surge, eventually pushing the central bank’s policy rate to its current 22-year high of 5.25%. to 5.5%.
Many economists and investors viewed a return to zero interest rates as unlikely and undesirable, especially for savers.
see: Investors said goodbye to the era of cheap money. Now what?
A recent survey of lenders in the U.S. leveraged lending market by FTI Consulting found that 73% of respondents expected the federal funds rate to end above 4% by the end of 2024.
Additionally, following expectations of interest rate cuts, the stability of the 10-year Treasury yield BX:TMUBMUSD10Y has increased in the new year, bringing additional confidence to capital markets and triggering a recent corporate borrowing offensive.
But as BofA’s Melentyev points out, not everyone has benefited equally. He thinks it’s likely that half of the issuers in his $500 billion “forgotten” category will remain free cash flow negative even if the Fed pulls the trigger on the cuts currently priced in by the market.
The probability of six rate cuts of 65 basis points in December 2024, which would push the central bank’s policy rate to a range of 3.75% to 4%, is pegged at 35.5%, according to the CME FedWatch tool.
“At the current issuance rate, it will take 5.5 years to address the funding need, which is expected to be completed within two years.”
The counterpoint to Melentyev’s argument is that every cycle washes out weak hands and creates opportunities.
Exchange-traded funds linked to the high-yield and leveraged loan markets have also rebounded over the past three months. SPDR Bloomberg High Yield Bond ETF JNK was up 7.2% through Friday, while Invesco Senior Loan ETF BKLN was up 1.2% in the same period. , according to FactSet data.
