Investors gorge on corporate bonds after Fed ‘capitulation’

High-quality corporate bond index marks best its start to the year since 1995.

  • By Joe Rennison,
  • Financial Times
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Corporate bond markets have staged their best start to the year in two decades, roaring back from a bout of volatility after the Federal Reserve pulled off one of its sharpest policy U-turns.

A widely tracked high-yield bond index run by ICE Data Services has returned 5.6 per cent so far this year — the most since 2001. A broad investment grade corporate bond index, also run by ICE Data Services, has returned 2.6 per cent over the same period, marking its best start since 1995, when the Fed put an end to an interest-rate hiking cycle.

The strong start to the year comes after the Fed stunned markets in January, distancing itself from its December talk of another two rate-rises in 2019 and raising the possibility that the next move in rates could be down, rather than up. That shift — apparently prompted by the fierce market sell-off towards the end of the year — is prompting investors to funnel cash into bonds, whose fixed interest payments become more valuable if base rates flatline or fall.

“Some of the numbers going after both investment-grade and high-yield issuance is pretty astounding in light of where we stood a month and a half ago,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management, a $25bn-in-assets firm.

Hans Mikkelsen, a strategist at Bank of America Merrill Lynch, said the “shift in rate expectations” was the main driver of the rally. “The Fed went from being pretty insensitive to what was happening in financial markets in December to completely capitulating in January.”

Investors had feared that further interest rate increases from the Fed could push the US economy into recession, bringing an end to the current credit cycle which has seen companies amass huge debt piles while rates have been low.

The potential impact on credit conditions pushed up spreads over US Treasuries on both investment grade and junk bonds in December. But the Fed’s pivot in January has squeezed spreads for both classes of corporate bonds.

A host of companies have taken advantage of the warmer conditions, with bumper bond sales from the likes of brewer Anheuser-Busch InBev (BUD) and tobacco giant Altria Group (MO).

High-yield bonds have also benefited from a shift in sentiment away from the previously red-hot loan market, where typically lower-rated or already heavily indebted companies seek out financing.

But Mr. Mikkelsen warned that a further increase in supply could test investor demand, threatening the rally seen so far. Other investors warned that the bright start to the year could be undermined if continued strength in the US economy leads the Fed, under chair Jay Powell, to resume a tightening of financial conditions.

“At least in the near term the market is hearing Powell as giving it a green light to reach for yield again,” said Henry Peabody, a portfolio manager at Eaton Vance. “We think it’s a bit misplaced.”

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