U.S. credit markets back on downward path as Fed weighs on risk assets

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FILE PHOTO: An eagle tops the U.S. Federal Reserve building's facade in Washington

By Davide Barbuscia

NEW YORK – A rally in U.S. credit markets after the U.S. Federal Reserve started hiking rates last month was short-lived and some corporate bonds hit new lows on Monday amid rising bond yields and concerns over the economic outlook.

BlackRock’s iShares iBoxx $ High Yield Corporate Bond ETF – an exchange-traded fund which tracks the U.S. junk-bond market – fell 0.6% to trade at $79.76 a share on Monday, its lowest since May 2020.

Its investment grade equivalent was also down sharply, by over 1%, hitting its lowest since March 2020.

Corporate bonds have had a rough start to the year but credit spreads – the interest rate premium investors demand to hold corporate debt over safer U.S. Treasury bonds – tightened after the Fed hiked rates in March.

That was in step with a stocks rally which was partly driven by investors comforted by more clarity on rate hikes and the Fed’s decisive action against surging inflation.

However, lingering concerns over the impact of tighter monetary policies on corporate profits and borrowing costs, as well as the possibility of a sharp economic slowdown as the Fed tries to cool the economy, have started to pressure U.S. credit markets again this month.

The Markit CDX North American Investment Grade Index, a basket of credit default swaps that serves as a gauge of credit risk, widened 6 basis points from the end of March to 72.843 basis points on Monday, as investors hedged bets on a deterioration in credit quality.

“Economic conditions are evidencing some signs of perhaps slowing somewhat down”, said Mark Luschini, Chief Investment Strategist at Janney Montgomery Scott.

“That can start to creep into widening credit spreads by way of investors taking perhaps a slightly more sober view about what are the conditions that are going to persist to allow those lower rated credits to continue to fund their debt financing”, he said.

U.S. Treasury yields rose last week on the back of hawkish signals by the U.S. central bank – increasingly determined to tighten financial conditions through rate hikes and so-called quantitative tightening, a plan to reduce its balance sheet.

On Monday, the benchmark 10-year U.S. Treasury yield rose to its highest level in more than three years as investors awaited key inflation data later this week to determine how hawkish the Fed will need to be on its policy path.

“The combination of faster rate hikes along with quantitative tightening is, at least potentially, a cocktail for drawing the liquidity conditions that are best suited to promote high flying equity names as well as the risky components of the fixed income market, credit and lower rated credit in particular”, said Luschini.

(Reporting by Davide Barbuscia; Editing by Chizu Nomiyama)


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