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Investors are pouring cash into US corporate bond funds at the fastest pace in more than three years, signalling a growing appetite for risky assets as markets call the peak in interest rates.
More than $16bn has flooded into corporate bond funds in the month to November 20, data from flow tracker EPFR shows, already a larger net inflow than any full month since July 2020.
The trend has been concentrated mainly in “junk” debt, with $11.4bn flowing into funds investing in these low-grade, high-yield bonds this month. Another $5bn has poured into investment grade funds, which hold better quality corporate debt.
The substantial inflows underscore how cooling inflation has fuelled predictions that the US Federal Reserve has finished its cycle of interest rate rises. The clamour for lower-rated bonds also reflects growing confidence that relief from high borrowing costs will allow highly indebted companies to navigate a slowing economy without a surge in defaults.
“We have seen a very big change in sentiment across markets,” said Will Smith, director of US high-yield credit at AllianceBernstein. Smith added that a “massive relief rally” in US Treasuries, as investors race to close out bets on further price declines, had been echoed in corporate debt.
The Fed has turned the screws aggressively on monetary policy since March last year, taking borrowing costs from near zero to a target range of 5.25 per cent to 5.5 per cent in a bid to curb inflation. That has translated into a greater interest burden for corporate America — sparking concerns about a wave of defaults as riskier businesses struggle to service their debt.
However, the Fed has held rates steady since July. And closely watched labour market data for October showed a substantial slowdown in hirings, with just 150,000 new US jobs created — beneath forecasts and much lower than the prior month’s number.
Last week, data showed that inflation had slipped more than expected to 3.2 per cent — the first decline since June.
In response, traders have slashed their expectations of another rate rise before the end of the year, with futures markets pricing in two cuts by July — even as the central bank has signalled it may need to keep borrowing costs higher for longer.
The shift in the outlook for interest rates has boosted corporate bond valuations. The average premium paid by US investment grade borrowers above US Treasuries sits at 1.17 percentage points, Ice BofA data shows, down from 1.3 percentage points as recently as November 1. Average junk bond spreads have narrowed more sharply, from 4.47 percentage points to 3.95 percentage points.
November’s inflows come after high-yield funds suffered more than $18bn of outflows in the year to October 31. Some economists and investors worry that the fresh flood into corporate debt markets could reverse again, if it becomes clear that borrowing costs are to remain high for the foreseeable future — helping to push down bond prices and fuel a widening of credit spreads.
“I think you’re seeing investors rush into fixed income, thinking that we’ve seen the highs in interest rates because of a few data points,” said John McClain, portfolio manager at Brandywine Global Investment Management.
“I think that’s kind of foolish, frankly,” he added. “This feels very similar in terms of market movement to both 2019 and 2021, where we saw material ‘melt-ups’ into the end of the year — risk-chasing.”
The lowest-rated companies in the high-yield index would be most vulnerable in a “higher for longer” scenario, according to Apollo chief economist Torsten Slok. “They have more leverage, they have lower coverage ratios, they have weaker cash flows,” he said, meaning that default rates may continue to increase.
November’s inflows indicate that “the pendulum is certainly [swinging] in the direction of saying, ‘hey, inflation is behind us and everything is fine’,” Slok added.
“The problem with that is that the pendulum can very, very quickly swing back” if a well-known company defaults on its debt, he added.
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