Category: Insight

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$3.4 billion and year to date flows stand at -$44.0 billion.  New issuance for the week was $0.9 billion and year to date issuance is at $68.9 billion.

(Bloomberg)  High Yield Market Highlights

• U.S. junk bonds are headed toward the fourth straight weekly loss as investors pull cash out of high-yield funds amid growing concerns that the economy is headed toward a recession. Yields are hovering near a two-year high of 8.56% and spreads at a 21-month high of +525bps.  Barclays Plc’s Brad Rogoff said in a note Friday that high inflation will likely cause the fundamentals supporting the high-yield market to “deteriorate,” putting pressure on “lower-margin or more-leveraged companies.”
• “The average weighted debt to EBITDA leverage for CCCs is 10.5 times, with 1.8x interest cover indicating unsustainable capital structures over the next two years,” S&P Global wrote on Thursday. CCC yields were close to breaching the 13% level and spreads were near distressed levels, closing at +966bps as tightening financial conditions fuel worries about default risk.
• U.S. high yield funds saw an outflow for week.
• The junk bond primary market was virtually nonexistent amid rising yields and fears of slowing economic growth. Month-to-date issuance is at a modest $9.25b, making it the slowest June in more than a decade.
• JPMorgan revised its junk-bond supply forecast for 2022 to $175b from the earlier estimate of $425b made in November.

(Bloomberg)  Powell Says Soft Landing ‘Very Challenging,’ Recession Possible

• Federal Reserve Chair Jerome Powell gave his most explicit acknowledgment to date that steep rate hikes could tip the US economy into recession, saying one is possible and calling a soft landing “very challenging.”
• “The other risk, though, is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy,” Powell told lawmakers on Wednesday. “We can’t fail on that task. We have to get back to 2% inflation.”
• The Fed chair was testifying before the Senate Banking Committee during the first of two days of congressional hearings. In his opening remarks, Powell said that officials “anticipate that ongoing rate increases will be appropriate,” to cool the hottest price pressures in 40 years.
• “Inflation has obviously surprised to the upside over the past year, and further surprises could be in store. We therefore will need to be nimble in responding to incoming data and the evolving outlook,” he said.
• Powell’s remarks reinforced comments at a press conference last week after he and his colleagues on the Federal Open Market Committee raised their benchmark lending rate 75 basis points — the biggest increase since 1994 — to a range of 1.5% to 1.75%.
• “We understand the hardship high inflation is causing,” Powell said Wednesday. “We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so.”
• “Financial conditions have tightened and priced in a string of rate increases and that’s appropriate,” Powell said in response to a question following his opening remarks. “We need to go ahead and have them.”
• The Labor Department’s consumer price index rose 8.6% last month from a year earlier, a four-decade high. University of Michigan data showed US households expect inflation of 3.3% over the next five to 10 years, the most since 2008 and up from 3% in May.
• The rising cost of living has angered Americans and hurt the standing of President Joe Biden’s Democrats with voters ahead of November congressional midterm elections.
• Fed officials have admitted that they were too slow to tighten and are now trying to front-load rate increases in the most aggressive policy pivot in decades.
• While a recession isn’t in the Fed’s forecast, economists are increasingly flagging the likelihood of a downturn sometime in the next two years.
• Former New York Fed President Bill Dudley said in a Bloomberg Opinion column Wednesday that a recession is “inevitable” within the next 12 to 18 months. An economist at the Fed, Michael Kiley, said in a paper Tuesday that the risk of a large increase in the unemployment rate is above 50% over the next four quarters, based on a simulation incorporating inflation data, unemployment, corporate bond yields and Treasury yields.
• While he said that he did not see the likelihood of a recession as particularly elevated right now, he said that it was “certainly a possibility. It is not our intended outcome at all,” noting that events in the last few months have made it harder for the Fed to lower inflation while sustaining a strong labor market.
• A soft landing “is our goal. It is going to be very challenging. It has been made significantly more challenging by the events of the last few months — thinking there of the war and of commodities prices and further problems with supply chains.”
• “The tightening in financial conditions that we have seen in recent months should continue to temper growth and help bring demand into better balance with supply,” he said.
• Policy makers’ latest forecasts, released last week, show the level of rates roughly doubling in the second half of the year to a target range of 3.25% to 3.5%. They saw rates peaking next year at 3.8%.
• Officials have also begun shrinking their massive balance sheet. The combined impact of higher borrowing costs and so-called quantitative tightening is expected to come at some cost to jobs.
• Unemployment was near a 50-year low of 3.6% last month and Fed officials forecast it rising to 4.1% by the end of 2024, when they see rates peaking at 3.8%. Inflation was projected to decline toward their 2% goal by then from current readings of more than three times that level, according to the gauge that the Fed targets.

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$6.4 billion and year to date flows stand at -$40.6 billion.  New issuance for the week was $2.7 billion and year to date issuance is at $68.0 billion.

(Bloomberg)  High Yield Market Highlights

• U.S. junk bonds are headed toward the biggest weekly loss in more than two years as yields jump to a 26-month high of 8.56% amid fears that the 75 basis points hike in interest rates by the Federal Reserve, the biggest since 1994, could trigger a recession.
• High-frequency credit card data shows that consumer spending growth has started to fade, suggesting more weakness in risk assets, Brad Rogoff of Barclays wrote on Friday.
• With the Federal Reserve focused on inflation and willing to take collateral risk, downside risk worsens, Barclays wrote.
• However, high yield will trade in the +450 to +475bps range, despite periods of overshooting, Barclays’ analysts wrote.
• The spreads breached the +500 mark to close at +508bps, the widest since November 2020 amid a broader risk-off move.
• The losses spanned across high-yield ratings amid growing concern that a recession could fuel a rapid increase in credit risk.
• CCCs, the riskiest of junk bonds, are also expected to see the most weekly loss since April 2020, with week-to-date losses at 3.01%.
• CCC yields rose to 12.88%, the highest since May 2020.
• The broader junk bond index is on track to post losses for the third straight week, with week-to-date losses at 3.09%, the most in a week since March 2020.
• The steady risk aversion was becoming evident in the primary market with several new issues pricing at a steep discount.
• The primary market was fairly quiet this week. The month-to-date tally stood at $9.3b, down 63% from comparable period last year.
• Junk bonds will wait and watch as US equity futures rebound cautiously along with stocks in Europe after a rout triggered by fears of an economic downturn as major central banks close the liquidity taps.

(Bloomberg)  Powell Sets Path to Restrain Economy and Stop Runaway Inflation

• Federal Reserve Chair Jerome Powell took a step toward assuming the mantle of inflation slayer Paul Volcker, all but acknowledging that reining in run-away price pressures may result in a recession.
• Declaring that it’s essential to bring inflation down, Powell engineered the central bank’s biggest interest-rate increase since 1994 on Wednesday and held out the distinct possibility of another jumbo three-quarter percentage point increase in July.
• He openly endorsed for the first time raising rates well into restrictive territory with the aim of cooling off the labor market and pushing joblessness up — a strategy that in the past has often resulted in an economic downturn.
• “This is a Volcker-esque Fed,” said Diane Swonk, chief economist at Grant Thornton LLP. “That means the Fed is willing to take a rise in unemployment and a recession to avert a repeat of mistakes of the 1970s. Supply shocks won’t correct themselves, so the Fed must reduce demand to meet a supply constrained world.”
• The shift in stance carries perils not only for the economy, but for financial markets and President Joe Biden. Stocks have tumbled in recent months as the Fed has tightened credit to get on top of inflationary pressures that have proved more persistent and widespread than it expected.
• Biden has seen his popularity plunge as inflation has soared. A recession — and the higher unemployment that would bring — would rob the president of one of his few talking points in touting the benefits of his policies for the economy.
• An increasing number of economists are projecting a downturn next year as the Fed struggles to get on top of inflation that’s running at its highest level in four decades. Nearly 70% of academic economists polled by the Financial Times and the University of Chicago foresee a contraction in gross domestic product next year, according to survey released June 13.
• Fed policy makers’ projections released after the meeting show the economy continuing to grow this year and next, though at a subpar pace. But they also foresee unemployment rising, something that usually only happens during a recession: Joblessness is forecast to rise to 4.1% at the end of 2024 from 3.6% now, according to the median forecast.
• While maintaining that a 4.1% jobless rate would still be historically low, Powell made clear that the Fed’s No. 1 goal was not tending to the labor market but getting inflation under wraps.
• “I will begin with one overarching message,” the Fed chair said at the start of his press conference. “We’re strongly committed to bringing inflation back down, and we’re moving expeditiously to do so.”
• To that end, policy makers are projecting a steep rise in interest rates in coming months. They now see the federal funds rate they control rising to 3.4% by the end of this year and 3.8% at the end of 2023. That’s well above the 2.5% rate they reckon is neutral for the economy — neither spurring nor restricting growth — and compares with the current fund’s rate target of 1.5% to 1.75%.

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $0.4 billion and year to date flows stand at -$36.1 billion.  New issuance for the week was $1.3 billion and year to date issuance is at $65.2 billion.

(Bloomberg)  High Yield Market Highlights

• U.S. junk bonds are headed toward the biggest weekly loss in two months after declining for five straight sessions, the longest losing streak in almost two months, as the Fed-fueled rally faded amid concerns that hawkish monetary action may precipitate an economic recession.
• Inflows into junk-bond funds have moderated, signaling investors are turning more cautious with the rally waning steadily amid fears of an imminent recession.
• Weekly losses spanned across all high yield ratings. BBs are also on track to post the biggest weekly loss in two months. The loss follows a decline in eight consecutive sessions, the longest losing streak since February.
• BBs are the worst performers week-to-date with losses of 1.46%.
• CCC yields rose to 11.62%. The index is poised to the best performing asset in the high yield market, with modest losses of 0.83% week-to-date.

(Bloomberg)  Yellen Warns Inflation to Stay High, Recants Again on Transitory

• Treasury Secretary Janet Yellen told US lawmakers peppering her Tuesday with questions about the surge in the cost of living that inflation is likely to stay high and that she ought not to have termed big price increases as “transitory” last year.
• Yellen, in a Senate Finance Committee hearing, continued to defend President Joe Biden’s $1.9 trillion American Rescue Plan, which Republicans have blamed for helping drive inflation to a four-decade high.
• “Senator, we’re seeing high inflation in almost all developed countries around the world, and they have very different fiscal policies,” Yellen said in response to Montana Republican Steve Daines. “It can’t be the case that the bulk of the inflation we’re experiencing reflects the impact of the ARP.”
• She acknowledged once again that both she and Federal Reserve Chair Jerome Powell erred in 2021 by forecasting that high inflation wouldn’t persist.
• “Both of us probably could have used a better term than ‘transitory,’” she said.
• “There’s no question that we have huge inflation pressures, that inflation is really our top economic problem at this point and that it’s critical we address it,” she added. “I do expect inflation to remain high although I very much hope that it will be coming down.”
• Lawmakers from both sides of the aisle highlighted their own concerns with inflation, ahead of midterm congressional elections in November where Democrats will be challenged to retain their control.
• Yellen, along with Democratic senators, highlighted proposals to help address living costs through measures including lowering prescription drug costs. Republicans attacked Yellen for wanting yet more spending even after the ARP had fueled price gains.
• The Treasury chief repeated her view that unexpected shocks, including Russia’s invasion of Ukraine, were not predictable and contributed significantly to the inflation Americans continue to experience.
• The hearing was on Biden’s 2023 budget proposal. Yellen told lawmakers that the plan would complement the Fed’s efforts to rein in inflation by enacting programs that would help contain costs for Americans on energy, health care and pharmaceuticals. Deficit reduction would also help, she said.

(Bloomberg)  US Inflation Quickens to 40-Year High, Pressuring Fed and Biden

• U.S. inflation accelerated to a fresh 40-year high in May, a sign that price pressures are becoming entrenched in the economy. That will likely push the Federal Reserve to extend an aggressive series of interest-rate hikes and adds to political problems for the White House and Democrats.
• The consumer price index increased 8.6% from a year earlier in a broad-based advance, Labor Department data showed Friday. The widely followed inflation gauge rose 1% from a month earlier, topping all estimates. Shelter, food and gas were the largest contributors.
• The so-called core CPI, which strips out the more volatile food and energy components, rose 0.6% from the prior month and 6% from a year ago, also above forecasts.
• The figures dash any hope that inflation had already peaked and was starting to ebb. Record gasoline prices, paired with unrelenting food and shelter costs, are adding strain to Americans’ cost of living, suggesting the Fed will have to pump the brakes on the economy even harder. That raises the risk of a recession.
• “There’s little respite from four-decade high inflation until energy and food costs simmer down and excess demand pressures abate in response to tighter monetary policy,” Sal Guatieri, senior economist at BMO Capital Markets, said in a note.
• In May, prices for necessities continued to rise at double-digit paces. Energy prices climbed 34.6% from a year earlier, the most since 2005, including a nearly 49% jump in gasoline costs. Gas prices so far in June have climbed to new highs, signaling more upward pressure in coming CPI reports and therefore keeping the Fed in the hot seat.
• Grocery prices rose 11.9% annually, the most since 1979, while electricity increased 12%, the most since August 2006. Rent of primary of residence climbed 5.2% from a year earlier, the most since 1987.
• “Tighter monetary policy will not help much with surging global commodity prices or structural changes in the way people spend and live in the post-pandemic economy,” Wells Fargo & Co. economists Sarah House and Michael Pugliese said in a note.
• That likely spells further trouble for President Joe Biden, whose approval ratings have sunk to new lows ahead of midterm elections later this year. While the job market remains a bright spot, decades-high inflation is crippling confidence among the American people and largely outpacing wage gains.

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $4.6 billion and year to date flows stand at -$36.6 billion.  New issuance for the week was $6.0 billion and year to date issuance is at $63.9 billion.

(Bloomberg)  High Yield Market Highlights 

• The U.S. junk bond rally is steadily fading as it is heads toward a modest weekly gain of 0.04%, a big drop from the biggest weekly jump in more than two years in the previous week with returns of more than 3%. The junk bond primary market saw a flurry of new issuance in recent days from a stream of borrowers, the busiest week since mid-January.
• High yield issuers “testing market access in the coming weeks should provide better visibility on clearing levels and potentially induce further repricing in secondary spreads,” Morgan Stanley analysts led by Srikanth Sankaran wrote on Thursday.
• The recent rally is more a “reflection of credit markets still trying to calibrate growth fears and tighter liquidity,” Morgan Stanley wrote.
• The borrowers rushed to take quick advantage of the rally unleashed last week after the release of the Fed minutes signaled that the central bank may slow its monetary tightening after the expected half-percentage-point rate increases at each of the next two meetings.
• After a big surge of issuance on Wednesday pricing more than $4b to make it the busiest in five weeks, there was a marked slowdown after that. Thursday was quiet with just one deal pricing for $500m and there is nothing scheduled for pricing today.
• While the primary market was revived after a quiet and slowest May since 2002, the market was led by low risk BB rated bonds as the borrowers were testing access and risk appetite of the market.
• The spreads have tightened too fast, Barclays wrote on Friday. The credit cycle is aging quickly, and the macro picture remains gloomy in both the US and the rest of the world, Brad Rogoff, head of fixed income research at Barclays, wrote in note.
• “We expect volatility to remain elevated as the Fed tries to find the right balance,” Barclays emphasized.
• The sharp surge and sudden drop in yields and prices will continue until clarity emerges from the Federal Reserve on the right balance.
• Junk bonds may stall as US equity futures drop after a report that Tesla Inc. Chief Executive Officer Elon Musk said the electric carmaker needs to cut staff amid a gloomy economic outlook. Meanwhile, oil is headed for a sixth weekly advance after a keenly anticipated OPEC+ meeting delivered only a modest increase in output.

(Bloomberg)  Fed Starts Experiment of Letting $8.9 Trillion Portfolio Shrink

• The Federal Reserve is about to start shrinking its $8.9 trillion balance sheet, deploying a second tool along side higher interest rates to curb inflation, though officials don’t know just how effective it will be.
• After doubling in size through asset purchases in the first two years of the pandemic, the balance sheet will be reduced at a pace that’s almost twice as fast as after the last financial crisis. While the process officially commences on Wednesday, the first US Treasury securities won’t run off until $15 billion mature on June 15.
• The Fed is capping monthly runoff at $47.5 billion — $30 billion for Treasuries and $17.5 billion for mortgage-backed securities — until September. Those thresholds will then double to a combined $95 billion. That compares to a peak of $50 billion a month when the Fed performed the exercise starting in 2017.
• Officials say the reduction will work in tandem with interest-rate increases to cool price pressures by tightening financial conditions. But it’s not clear how much impact the balance sheet will have. As Fed Governor Christopher Waller put it in a speech on Monday, estimates “using a variety of models and assumptions” are “highly uncertain.”
• The Fed deployed massive asset purchases during the 2008 financial crisis for the first time since World War II, expanding the balance sheet to about $4.5 trillion by the time it stopped buying at the end of 2014. It then waited three years before allowing it to begin shrinking at the end of 2017, reducing it to about $3.8 trillion by September 2019.
• Uncertainty over the course of the balance sheet was said by commentators to have contributed to the market turmoil that ultimately helped bring an end to the Fed’s last rate-hike campaign, which concluded in December 2018. Now, the Fed is also raising its benchmark rate at a faster pace in a bid to tighten financial conditions and tame inflation, which in recent months has reached the highest levels in four decades.
• Minutes of the Fed’s most recent policy meeting, on May 3-4, said that, “Regarding risks related to the balance-sheet reduction, several participants noted the potential for unanticipated effects on financial market conditions.” The next meeting is scheduled for June 14-15.