Why U.S. debt markets are "shifting in a big way"
If January is any indication, the U.S. debt market wants to put the angst of the rising rate era behind it.
What's happening: The corporate bond and loan markets — where large companies borrow money — just saw one of their busiest months in recent memory.
Why it matters: Borrowers reset their expectations, and aren't sitting on the sidelines waiting for rates to return to their pre-2022 levels. Meanwhile, lenders aren't so nervous about an impending recession that they withhold credit.
- In short, a much-feared debt market dislocation as a result of the Fed's record tightening spree hasn't happened.
State of play: Placements of new loan and bond deals soared in January, after dropping sharply in 2022, and see-sawing 2023, according to PitchBook LCD.
- Most notably, riskier deals reappeared — like bonds with "CCC" ratings (the lowest credit rating); and purely opportunistic stuff like loans backing dividends.
- "Dividend recaps are a big indicator — when people are willing to do those, that means investor demand for credit is strong," says David Rosenberg, high-yield portfolio manager at Oaktree Capital.
How we got here: The market started rallying in November as data continued to show a strong economy paired with inflation dissipating. The mood was turbo-charged after the Federal Reserve telegraphed that rates had likely peaked — and that cuts were on the table in 2024.
- This brought a wave of investor cash into credit funds. The high-yield bond index was yielding a relatively high 8% in December, while the outlook for the economy was pretty rosy — that's a rare sweet spot.
- "In the past when the credit market offered yields like this, it was because everything was really scary and nobody wanted to lend," says Rosenberg.
- "Most fixed-income funds are seeing more investor dollars come in, and frankly, there's not enough incremental supply to absorb all of it," says Christopher Miller, credit portfolio manager at Neuberger Berman.
In the weeds: Much of the demand is coming from big institutions like pensions and insurance companies that make major asset allocation decisions for the coming year each December.
- Large institutions with money to invest send out RFPs, or requests for proposals, to fund managers, so those managers can compete for their business.
- Rosenberg says the $10 billion multi-asset credit strategy he helps run received a surge of RFPs in the second half of 2023, leading to its highest annual RFP volume since its inception seven years ago.
- "Institutions that were underweight credit are now shifting in a big way, and that's had a big impact on the market," he says.
Meanwhile: Companies, for their part, were ready to come to market and take advantage of the demand.
- "It's as good of an environment as we've seen since early 2022," says Blair Shwedo, head of fixed-income sales and trading at U.S. Bank. "So if you're a borrower, why try to hold out for even better when this is really the best it's been in over two years?"
The big question: How much will this recent rally help the companies with the most troubled balance sheets refinance?
- There are probably about 25 to 30 "CCC" bonds out there that need to be refinanced this year, estimates Meghan Robson, head of U.S. credit strategy at BNP Paribas. "It's still debatable whether those deals will able to get done," she says.
- Further evidence of a soft landing will help, she says. But if the economic data weakens, that would be a roadblock.