Expectations for faster pullback in Fed support takes steam out of credit

Corporations are rushing to issue more debt amid the Federal Reserve’s messaging that it may move quicker to tighten the spigot on its easy money policies.

Despite the emergence of the Omicron variant, Fed Chairman Jerome Powell and a chorus of other Fed officials recently signaled they were likely to support a faster wind-down in the Fed’s asset purchase program.

If the Fed can fully end the so-called quantitative easing program early next year, the central bank would have the flexibility to start raising interest rates earlier than the timeline previously set in early November.

The prospects of earlier — and perhaps more aggressive — interest rate hikes are pushing companies to pull forward issuance of corporate bonds. Lower Fed rates generally correspond to cheaper borrowing costs. And messaging that the Fed may move faster appears to have spooked issuers into pulling forward bond issuance ahead of any rate hikes.

BofA Securities noted that the supply of investment-grade corporate debt jumped to $57 billion in the week ended Nov. 15, as chatter over an accelerated taper began building.

“For companies thinking about their own situation and taking an upper hand knowing interest rates are low now, spreads are tight now, and markets are wide open now: go ahead and issue the bonds when you can,” said Tom Graff, head of fixed income at Brown Advisory.

Warning signs have flashed in credit markets as early as October. In that month, BofA Securities observed a slowdown in inflows into U.S. investment-grade funds and ETFs, coinciding with a 10-year U.S. Treasury yield that was trending higher.

Emily Roland, co-chief investment strategist at John Hancock Investment Management, said adding some high-yield bonds might be an attractive opportunity. But she said to stay away from junkier bonds at the bottom of the rating spectrum.

“It’s going to be hard to sort of squeeze more out of the lower rungs of the high-yield bond market and we would really think about those BBs, those fallen angels that continue to have the ability to be upgraded as this economic cycle unfolds,” Roland told Yahoo Finance Tuesday.

Still, uncertainty looms over the asset class.

Corporate bond spreads widened in November amid heavy supply and lower demand, sparking concerns that more volatility in spreads could be coming in 2022. But investment-grade spreads still remain historically low (104 basis points now, comparable to pre-pandemic levels).

BofA Securities pointed out that the emergence of Omicron shook equity markets but made little waves in spreads, reinforcing their analysts’ views that the “number 1 risk” for spreads remains “a more hawkish Fed.”

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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