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US Debt Buyers Brace for Fed to Hike ‘Until Something Breaks’

·4 min read
US Debt Buyers Brace for Fed to Hike ‘Until Something Breaks’

(Bloomberg) -- US corporate debt markets fluctuated between losses and gains after Federal Reserve officials raised interest rates by 75 basis points for the third consecutive time and stoked expectations among debt investors for even tighter policy ahead.

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A key measure of perceived US credit risk, the Markit CDX North American Investment Grade Index, which declines as credit risk drops, widened 2.11 basis points to 100.6 as of 4:31 p.m. in New York to the highest on an intraday basis since July 6, after initially tightening. The CDX high-yield index, which rises as credit risk declines, fell 0.5 points to 98.5.

“I believe 75 is the new 25 until something breaks, and nothing has broken yet,” said Bill Zox, a high-yield portfolio manager at Brandywine Global Investment Management. “The Fed is not anywhere close to a pause or a pivot. They are laser-focused on breaking inflation. A key question is what else might they break.”

Bond sales in the high-grade market stalled on Wednesday as the Federal Reserve decision and press conference take center stage. Bond issuance is running well below forecasts for the month, and issuers remain cautious about selling debt amid rising borrowing costs. Average high-grade bond yields rose to a fresh high of 5.24% on Tuesday, a level last seen in August 2009.

Here’s the initial reaction from investors in corporate credit to the Fed decision:

Brandon Pizzurro, director of public investments at GuideStone Capital Management:

“We shouldn’t run over the fact that we just got our third straight 75 basis point hike. It’s a clear signal of what needs to be done here to remedy everything. All signs point to the Fed continuing down this hawkish road.”

Baylor Lancaster-Samuel, vice president of fixed income at Amerant Investments Inc.:

“The U.S. seems more and more likely to enter a recession, and ultimately there is no way that banks will avoid some impact on the credit quality in that scenario. Despite all the headwinds, bank bonds are looking cheap. Banks are still making money, lots of it, and the post-crisis regulatory capital and liquidity standards are light years better than where they were pre-financial crisis. One problem with buying corporate bonds right now is the fear that they may be cheaper tomorrow.”

Ajay Rajadhyaksha, global chairman of research at Barclays Capital Inc.:

“This is a very, very aggressive Fed move, especially for the next few meetings. They have essentially locked in 75 bp for the next meeting, regardless of data, since they are calling for 4.4% on the funds rate by the end of this year.”

Jan Szilagyi, co-founder and CEO of Toggle, an investment research firm:

“The Fed seems to be borrowing heavily from the 1980s’ playbook by the legendary chairman Paul Volcker. They have a brief window to act aggressively, and they seem eager to use it.”

Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors:

“It shouldn’t be a surprise. I don’t think a week from now the high-yield market would look a lot different than it did before the announcement. 1% would have been a negative surprise. That’s when people ask what the Fed knows that we don’t know. But that’s out of the way.”

Jim Caron, chief fixed income strategist at Morgan Stanley Investment Management:

“The Fed’s front-loading their willingness to move, to use monetary policy to fight inflation. But at the same time, it also increases the risk for recession down the road. If you increase the probability of recession and increase the probability of a deep recession, then it should start to weigh on spreads.”

Hunter Hayes, portfolio manager of the Intrepid Income Fund at Intrepid Capital Management:

“Credit markets are stuck between Scylla and Charybdis - whether it’s higher rates, or spreads widening as the economy starts to weaken, it seems likely that we will soon retest the June lows. Pockets of credit, mainly shorter-dated, high quality names, look interesting here, but you have to pick your spots carefully.”

Justin Gmelich, global head of markets at King Street Capital Management:

“It takes time for the real impact of Fed hikes to feed through. This is a relief rally. We’ll maintain a defensive posture from a credit position standpoint, and I think that’s a crowded view. But if 100bps is off the table, maybe folks are a little bit underinvested now and may put a little bit of money to work.”

Steven Boothe, a portfolio manager for global and US investment-grade bonds at T. Rowe Price:

“The Fed is sending a clear message they do not want cuts getting priced into the market next year, and they will be slow to react until inflation comes off. Today’s Fed news is fairly balanced for credit. Higher all in yields and positive technicals will continue to lend support to the asset class.”

(Updates prices in second paragraph, adds new comments in third, penultimate and last paragraphs)

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