The Fed has to say it will stop buying corporate bonds to break the feedback loop, says this fixed income CIO


Say it if you mean it.

Brad Tank, chief investment officer of Fixed Income at Neuberger Berman, believes the Federal Reserve will have a hard time telling investors the party is over, even if it never plans to hit the corporate bond market by $ 10 again To support $ 7 trillion.

“There now appear to be two types of assets in the financial markets: those that are eligible for major central bank purchases and those that are not,” Tank wrote in a market note for the $ 402 billion asset manager.

He believes that US corporate bonds are still in “appropriate” stock according to a number of metrics, despite the Fed announcing in early June that it would sell nearly $ 14 billion in corporate debt accumulated during the pandemic.

Read: Is the Fed’s “tightening cycle” already taking place?

Most of the Fed’s recent security purchases were in US Treasuries TMUBMUSD10Y,
and agency Pfandbriefe FNMA,
+ 0.88%

+ 0.73%,
since his balance sheet has grown to one Record of $ 8.1 trillion to stabilize the economy during the pandemic recovery.

A year ago, Fed Chairman Jerome Powell said the Fed was not an “elephant” running through corporate bond markets and insisted that it support credit markets to limit potential damage to businesses during the Crisis faced a liquidity crisis.

However, Tank still sees doubts from investors as to whether the Fed plans to ditch corporate bonds forever, including the “slump” in volatility in the sector over the last 15 months when the central bank started buying corporate bonds for the first time.

Spreads slumped to a new post 2008 low of 87 basis points last week in the ICE BofA US Corporate Index, above the risk-free Treasury rate, when stocks were sold, the dollar soared, and Treasury yields plummeted.

The potential problem is that as “confidence grows that a price insensitive buyer is ready to support the investment grade market in the event of a major sell-off, liquidity crisis, or spike in volatility, we believe investors will leads to a slightly lower price ”. -Sensitive and also a little less concerned about downside risk, “wrote Tank.

The longer that volatility is kept in check in an asset class, the more investors, including buyers who use leverage, often increase their allocation to a sector, he said. “Remember, this is a feedback loop,” where a larger buyer base can translate into even less volatility, he added.

While corporate bonds have been largely stable, equity price volatility has increased recently, including the Dow Jones Industrial Average DJIA,
+ 1.76%,
which posted its best day since March on Monday due to economic optimism but last week posted its worst weekly decline since October.

The defeat was largely attributed to Powell, who signaled that the full range of central bank support may not be in sight for as long as expected, with Fed officials anticipating two rate hikes in 2023 and underscoring that discussions about when to do so have started doing is possibly scaling back its bond purchase program.

Still, not everyone believes corporate bonds will remain immune to nervousness as financial markets deal with an eventual tightening of highly supportive monetary policy.

“We continue to believe that no one has seen this movie before,” wrote Hans Mikkelsen’s credit team at BofA Global Research in a customer note on Friday of its forecast for a modest sell-off in investment grade corporate bonds over the next six months. triggered by stumbling blocks in the economic reopening or possibly a faster path to higher interest rates after the first rate hike.

“We are looking for spreads that widen from the current level of 87bps to 125bps and to the broad range of the expected spread range of 90-113bps for 2021,” wrote the BofA team on US investment grade bonds .

Neuberger’s Tank believes the feedback loop of low volatility and increased allocations is difficult to derail, but not impossible.

“It is difficult to see what can break this loop beyond an explicit statement by the Fed that it will no longer buy corporate bonds (which seems unlikely given the potential disruption) or that the central bank is losing control of inflation,” he wrote .


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