Illustration: Sarah Grillo/Axios
The Fed's massive injections of liquidity have reopened much of the bond market, and after back-to-back weeks in which more than $100 billion flowed out of bond funds, investors have regained their bearings and now see opportunity.
What's happening: But after the hemorrhaging outflows relented last week, bulls may now be sticking their heads out a bit too far. Junk bond funds took in more than $7 billion for the week ended April 1, according to Refinitiv Lipper, setting a new weekly record.
- Junk bond companies have largely been locked out of issuing new debt, but firms with investment-grade ratings have flooded the market with a record $220 billion of new issuance in the last two weeks as the firms desperately seek cash.
Why it's happening: "The Fed came in with its massive bazooka, addressed the liquidity concerns and it’s gone from a buyer’s market to seller’s market," Mike Collins, senior portfolio manager at Prudential's PGIM Fixed Income, tells Axios.
- "You couldn’t sell a bond before, today you can’t buy a bond."
Yes, but: "While the Fed can have a very direct impact on liquidity… the ability of the Fed to have a major impact on the real economy is very much in question," Mike Swell, co-head of fixed income global portfolio management at Goldman Sachs Asset Management, tells Axios.
- If the slowdown for businesses lasts just a few months, "you are going to have mid-teens type returns in credit markets ... and it’s a slam dunk," Swell adds.
- "But if we have global commerce and production stop for nine months to a year, that’s going to be really, really serious for companies that are leveraged."
Flashback: Investors pulled out of bond funds at a record pace during March, data from the Investment Company Institute show.
- Bond mutual funds and ETFs saw more than $215 billion of outflows during the two weeks ended March 25, surpassing previous record highs by a country mile.
The bottom line: While the Fed has taken unprecedented action, there are significant portions of the bond market where the central bank may not be willing or able to provide funding.
- "There is a point where investors need to make a decision and have consequences on making risky investments," Tom Simons, money market economist at Jefferies, tells Axios.
- "If that means defaults on bonds that were already low-rated before [the COVID-19 outbreak] happened, the Fed is likely going to let that happen."
In just the last three weeks, the Fed’s balance sheet has mushroomed by roughly $1.5 trillion and is now close to $1.3 trillion above its previous record high.
- With its promise of unlimited quantitative easing, investors are expecting the balance sheet to rise much further.
Watch this space: Credit-ratings agencies are beginning to take action and sound the alarm. Moody’s cut its outlook for corporate debt to negative last week, warning of "defaults rising in the coming quarters" and saying there was "no clear turning point yet."
- S&P Global said it expects a "surge in the corporate speculative-grade default rate to above 10% in the U.S."
- The last two weeks set a record for the fastest pace of downgrades, Bank of America Global Research pointed out, with net downgrades totaling $560 billion in March.