Analysis: Credit investors see more risk ahead as recession fears rise

NEW YORK, July 15 (Reuters) – Growing recession fears are prompting some investors to reduce the risk of their credit exposures as they brace for an economic slowdown the full extent of which remains highly uncertain.

US bonds have suffered from rising interest rates and inexorably high inflation, but in recent weeks the market’s attention has turned more to fears that the US Federal Reserve could cause a recession. as it tries to control inflation. Read more

As credit pressure mounts, some investors are looking to reduce their exposure to lower-rated credits and buy corporate bonds that are likely to be more resilient in an economic downturn.

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“We’ll still hold high yield, we’ll still hold some emerging markets, but I think we probably want to hold less going forward over the next three to six months,” said Nick Hayes, head of global equity strategy. strategic bonds at AXA Investment Managers. “We want to improve the quality of the whole portfolio because we may be heading into a really uncertain period,” he said.

That might not be easy, bond traders said, in part because rising borrowing costs are likely to dampen supply, which may limit investors’ ability to spread their exposure between secondary markets and primaries.

Benchmark yields on 10-year Treasury bills – a barometer of mortgage rates and other financial instruments – fell to 2.99% from around 3.5% on June 14. But the yield spread on the ICE BofA US High Yield Index (.MERH0A0), a benchmark used for the junk bond market, increased by more than 50 basis points over the same period and its Investment Grade (.MERC0A0) has also increased. Credit spreads generally widen when the risk of default increases.

High yield spreads hit a two-year high of around 600 basis points at the start of the month. The Fed has never raised rates under such tight credit conditions, BofA strategists said, noting that during the dot-com meltdown of 2001-2 and the financial crisis of 2008, the Fed cut its rates.

Still, high yield spreads don’t show the level of stress of some past crises. Spreads widened to over 2,000 basis points during the financial crisis and to over 1,000 basis points in early 2020 at the onset of the coronavirus outbreak.

For Jonathan Duensing, head of fixed income, US portfolio manager at Amundi US asset management, credit spreads point to an economic slowdown, albeit not severe, but they could widen further.

“We’re still a bit more cautious on overall exposure…selecting companies that we believe will be best positioned to perhaps weather the environment ahead,” he said.


Meanwhile, signs of recession are becoming more worrisome.

Some Wall Street banks have in recent weeks raised their expectations of an economic slowdown, and the inversion of the two-year/10-year U.S. Treasury yield curve – widely seen as a precursor to recession – has reached its highest level since 2000.

“What’s unusual about this slowdown (…) is that there are buffers suggesting that it might not be a very deep slowdown if it occurs,” Viktor said. Hjort, global head of credit strategy and desk analysts at BNP Paribas, referring to factors such as companies being in good financial shape coming out of the COVID-19 pandemic.

Yet it could be prolonged by the Fed’s lack of ability to help the central bank being constrained by inflation, he said.

A combination of higher interest rates and economic contraction could lead to more defaults among US companies and an adjustment in investor positions which, in turn, would hamper corporate access to debt markets.

“There’s no question that default rates are going to rise. It’s just a matter of how much and how fast,” said James Gellert, CEO of analytics firm RapidRatings.

Debt bankers say markets are still open to borrowers willing to pay premiums, but issuers are considering replacing bonds with short-term instruments or reducing the size of their fundraisings. For businesses that cannot afford to postpone their financing plans, the path has become uncertain.

“If the new-issue side isn’t there, then trying to find secondary bonds can be problematic,” said Dom Holland, head of US business development at LedgerEdge, a corporate bond trading platform in London. distributed ledger technology.

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Reporting by Davide Barbuscia; Editing by Megan Davies and Daniel Wallis

Our standards: The Thomson Reuters Trust Principles.

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