‘Priced to Perfection’ Starts to Unravel as Debt Markets Get Jitters

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(Bloomberg) — Credit investors got a dose of economic and geopolitical reality this week as hawkish comments from central bank officials about borrowing costs and tensions in the Middle East sent jitters through debt markets.

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The pullback was triggered in part by comments from Federal Reserve Bank of New York President John Williams, who said there’s no rush to cut interest rates and it’s possible that economic data could even warrant an increase if inflation persists.

The realization that the interest rate pivot had yet to arrive comes as the US economy continues its strong performance, causing financial conditions to loosen in recent months. As a result, the market isn’t yet showing signals that the central bank has restricted policy enough to begin easing, said Bill Zox, a portfolio manager at Brandywine Global Investment Management.

The return of the higher-for-longer mantra is a headache for insurance companies and pension plans which, flush with cash, sent demand for bonds soaring this year as they tried to lock in yields ahead of the anticipated cuts. Corporates responded by issuing more than $1 trillion of notes globally so far this year, the second-highest level since at least 2013. Now, however, investors are yanking money from high-yield funds and flows into shorter duration high-grade products have slowed dramatically.

Click here to listen to a podcast about how Morgan Stanley thinks credit could be in trouble if the Fed hikes.

For US investment-grade debt, spreads are only edging wider, and demand for many new issues is still strong. But signs of growing caution are clear in credit markets: Spreads on US junk debt have pushed wider after the rise in negative sentiment, and high-yield is poised for the biggest monthly loss on a total return basis since September 2022. It’s a marked reversal of the sense of complacency that earlier this month saw the global perception of risks from credit reach the lowest levels since February of last year, according to a Bank of America Corp. survey of fund managers.

Adding to the problems for policymakers, retaliatory strikes between Israel and Iran have sent oil prices higher, which could fuel inflation. The tensions in the Middle East also risk dampening demand for credit as investors seek havens like Treasuries instead.

Investor Pushback

One area where investors are pushing back is the leveraged loan market. While it continues to see demand, money managers have successfully pushed back on terms sought by issuers in recent days.

Rocket Software Inc. was forced to drop plans for a portable debt structure in recent days after feedback from money managers, according to people with knowledge of the matter. If the trend continues, it’s a potential positive for private credit providers, who have faced renewed competition in recent months from banks.

In Europe, it’s a different story. Traders are pricing around 80 basis points of cuts from the European Central Bank this year and officials have stressed they still plan to cut first in June and don’t need to wait for the Fed.

Still, the volatility this week means more than 70% of bond deals issued in Europe were in the red as of Friday morning in London, hurting retail investors, data compiled by Bloomberg News show.

Back in the US, some junk firms risk being hurt by the tightening in monetary policy.

“If those cuts get pushed out after the election, it could be a challenge for some of the lower-quality floating-rate issuers” who need to refinance, Meghan Robson, head of US credit strategy at BNP Paribas, said in an April 10 interview with the Credit Edge podcast. “That risk is not priced in yet but is something that could come into the debate as we get closer to the June and July timeline.”

Week in Review

Banks including JPMorgan Chase & Co., Wells Fargo & Co. and Goldman Sachs sold bonds this week in the US high-grade bond market, following their release of first-quarter results.
- Wells Fargo & Co. sold $4.25 billion on Monday, and C$1.25 billion ($900 million) of debt in the Canadian bond market on Tuesday, while Morgan Stanley sold $8 billion of bonds Wednesday, after it posted higher-than-expected quarterly revenue.
Banks are fighting back after private lenders have grabbed ever larger pieces of the lucrative business of financing leveraged buyouts: They’re serving as matchmakers on transactions between smaller companies looking for loans and private lenders eager to provide financing.
Wall Street’s securitization engine is revving up with issuance touching record levels as borrowers rush to secure funding before any credit market disruptions caused by the US general election.
The US leveraged loan market, as yet unruffled by the shift to a higher-for-longer view on interest rates, may soon join in the pain being felt in other asset classes.
Fading hopes that the Federal Reserve will soon cut rates are prompting US banks to re-evaluate the cost of their preferred stocks, potentially sparking a rush of deals for the crucial source of capital.
Banks are increasingly gathering orders for riskier high-yield bond and leveraged loan sales in private before formally announcing them to the broader market, in an effort to ensure deals find enough demand in difficult markets.
Blackstone Inc. led a roughly $2 billion financing package to Park Place Technologies to refinance the company’s debt and fund a payout to its private equity owners.
As climate change exacerbates droughts and wildfires, and utilities often take the blame for starting them, their assets are increasingly at risk.
Riverside Co. is exploring strategic options including a sale of its direct lending arm, Riverside Credit Solutions.
Asset manager Columbia Threadneedle Investments thinks that now is a good time to grab a bigger piece of the collateralized loan obligation market, recently saying it plans to expand its CLO business and become a regular issuer.
Library services companies Baker & Taylor and Media Source Inc. have held talks to combine and have approached direct lenders about financing for the potential deal.
Bayview Asset Management, a money manager, is in the process of marketing a complex bond that was created to help SoFi Technologies Inc., an online bank and lender, hedge part of its student loan book.
Vietnamese companies are cutting back on issuing new bonds as yields rise and the government heightens scrutiny on capital markets, a development that’s stirring refinancing risk concerns.

On the Move

Toronto-Dominion Bank’s head of private debt has left the firm amid a restructuring at the Canadian lender that includes cutting 3% of jobs globally.
Siemens AG has hired Milan Senicic as executive director to lead its corporate and leverage finance business in Australia.
ING appointed Gautam Saxena as head of corporate finance for the Asia Pacific region.

–With assistance from Michael Msika, Jill R. Shah, Paul Cohen and Dan Wilchins.