Credit Market Euphoria Is Like Rate Hikes Never Happened

(Bloomberg) — The most punishing interest-rate hikes since the 1980s. The high degree of uncertainty over when and how quickly central bankers will start reversing them. Yet another US lender hitting trouble barely a year after debt markets were upended by the collapse of one of the world’s biggest banks.

Credit investors have shrugged all of this off and are acting like the go-go days of the easy money era are back again.

Driven by a wall of new cash and a belief that the US Federal Reserve has served up a soft economic landing, normally sober debt investors are joining the “everything boom” that’s sent stocks and Bitcoin to giddy heights — even as the likes of Jamie Dimon of JPMorgan Chase & Co. and David Solomon of Goldman Sachs Group Inc. warn of markets racing ahead of themselves.

In credit, a risk-taking ebullience has taken hold. The lowest-rated traded company debt is outgunning safer assets: Spreads between junk bond yields and investment-grade counterparts are tight. Loan prices are high as demand soars. Negative-yielding bonds are back. And whether Fed Chair Jay Powell wants it or not, it’s getting easier for companies of all stripes to snag funding.

Chief financial officers are busy, grabbing the chance to borrow to help pay for dividends and share buybacks. India’s Adani Group, which had been under attack by short sellers, returned to the public bond market after a year’s hiatus and is looking at borrowing more. Used-car retailer Carvana Co.’s debt is no longer distressed. Issuers with ratings deep into junk territory are returning to the market and meeting strong demand. Private equity firms have even revived a risky form of buyout financing that had been shunned by the market.

For investors, this stampede into riskier assets is explained by a more benign view of the economy and the mountain of dollars they have ready to put to work. “People thought the economic threat was going to be central banks causing a recession,” said Robert Tipp, chief investment strategist for PGIM Fixed Income. “They’re now seeing the economy can get by with this level of rates. There’s a lot of long-term money looking to get invested.”

At the same time, there’s disquiet about whether the euphoria is getting out of hand. “There’s a version of the world where rates go up,” said Hunter Hayes, a portfolio manager at Intrepid Capital Management. “Things right now are priced for perfection. Something has to give.”

“It’s sort of insane where high-yield spreads are,” he added.

Harking Back

Powell’s comments on Thursday that he’s “not far” from being confident enough to cut rates — alongside European Central Bank President Christine Lagarde’s signaling a June reduction — may fuel the fire. On Friday, the US jobless rate climbed to a two-year high, pointing to a cooler yet resilient labor market and adding to speculation of looser monetary policy.  But there’s still some surprise that credit markets are going gangbusters given where things sit today. Higher rates mean investors can get decent returns from “risk free” assets like US Treasuries, and they put pressure on company borrowers.

The recent travails of beleaguered property lender New York Community Bancorp have also conjured up unhappy memories of this time last year when debt markets were roiled by the failure of Credit Suisse and the biggest US regional banking crisis since 2008.

Regardless, exuberance is percolating across all types of credit, harking back to early 2022, just before the Fed started hiking rates at the fastest pace in decades to fight inflation — sending risk assets plummeting and threatening to tip the global economy into recession. Anticipating Powell’s next moves will be one of the “potholes” investors have to navigate, Tipp said: “There are risks out there. You aren’t looking at a volatility-free market.”

Volatile or not, investors are betting on a brighter future. M&A funding’s back on tap for both high-grade and junk-rated companies, as the moribund deal market shows signs of life. Bank of America Corp. has described the market for blue-chip corporate bonds as bubbly, while Barclays Plc’s index meant to track creditor fear is at levels associated with complacency. Structured-finance markets are off to a hot start in 2024 as well. Sales of collateralized loan obligations in the US and Europe have had a record start to the year.

As a result, borrowers have stormed back into the market after two years of relative inactivity. Investment-grade bond sales also had a record beginning to 2024, while riskier companies are riding a refinancing wave in the leveraged-finance market to lower borrowing costs on existing loans.

Private prison operator CoreCivic Inc. was able to upsize its bond offering to $500 million this week and Stone Point Capital launched a $1.9 billion second-lien loan to help fund its leveraged buyout of Truist Financial Corp.’s insurance business last week. In private markets, some 24 lenders piled into a $3.3 billion loan for Ardonagh Group Ltd.

Credit Decoupled

For many strategists the problem of an overheated market isn’t so much that people are necessarily wrong to feel more chipper about the economy, or optimistic on the pace of rate cuts. It’s more a question of mispricing risk.

“For credit there is a floor to spread levels and there isn’t much more room to tighten, while if earnings continue to perform, equities have more proportional upside,” said Puneet Sharma, head of market strategies at Zurich Insurance Group. “US investment-grade spreads versus risk-free yields are close to historical tights and are pricing in all the good news from here.”​

Sam Wareham, a director in Deutsche Bank AG’s investment-grade syndicated debt business, said rampant demand means prices aren’t necessarily even reflecting what the Fed may or may not do. “Credit markets have begun to decouple somewhat from the broader macro narrative,” he said. “Last year, we were hanging on every data release and central bank speaker.”

And to be sure, investment-grade spreads, which have been pinned around a two-year low, drifted wider over the last week, and junk risk premiums have risen, too, after hitting close to their lowest level in two years. Some companies in trouble are still locked out of debt markets. The quality of the US junk bond market is eroding and default rates remain high.

For Gordon Shannon, a portfolio manager at TwentyFour Asset Management LLP, the argument that a lagged impact from higher rates is yet to hit the economy is valid, but he wonders whether stubbornness makes people stick to that view. “Are we just looking for reasons that the perfection priced in by current spreads can’t really be delivered,” he said. “Or are the more depressing anecdotes that sit behind the fairly rosy macro data worth listening to.”

Elsewhere in credit:

Moody’s Says Private Credit Returns Will Be Pressured by Banks

BlackRock Appoints Nataraj to Lead Private Credit in India

BlackRock Manager Predicts 40% Jump in Bank Risk Transfer Deals

The Credit Market Is Quietly Booming Again

–With assistance from Michael Tobin and Helene Durand.

(Updates with US jobs data.)

©2024 Bloomberg L.P.