High-quality bonds should hold up better than stocks, right? Particularly if defaults aren’t really the concern.
But that hasn’t been the case lately for debt issued by many Fortune 500 companies, a sector notably hit since the Federal Reserve changed its stance to urgently cool inflation.
US investment grade corporate bonds, the debt sold by many large companies in the S&P 500 SPX index,
they have posted a negative 10% total return so far in 2022 (see chart), after posting their worst quarterly loss since the global financial crisis, according to Mizuho.
The drop in high-quality corporate bonds compares with a total return of roughly minus 6% for the S&P 500 SPX Index,
and negative performance of 6% for bonds issued by municipalities and high yield companies.
“We’re in a tough environment,” said Jack McIntyre, portfolio manager at Brandywine Global Asset Management. “Bonds are selling, stocks are selling. The real return on cash is negative.”
McIntyre expects the bonds to be a “big buy” at some point, given the steady march higher in yields, though he expects bumps in the road.
On the one hand, the Fed needs to find out how much to increase your policy rate to help control inflation that is at a 40-year high, while also reducing its balance sheet by nearly $9 trillion, all without hurting the economy.
The hope is that rates, including the benchmark 10-year Treasury yield TMUBMUSD10Y,
will stabilize and help provide bonds with a firmer base. Corporate bonds and other debt that carry credit risks carry a price spread, or premium, above the risk-free Treasury rate, which has spiked dramatically this year as Fed officials have spoken more harshly about the inflation.
Corporate defaults have remained low, following an early deluge during the pandemic, and could remain so for a few years, given the extremely low-cost financing that many large companies secured in the past two years.
That doesn’t make it any easier for investors who hold trillions in low-coupon bonds that won’t be paid off for another decade or so, or longer in some cases.
“I think individual investors are still licking their wounds, given the negative total returns,” said Travis King, head of investment-grade credit at Voya Investment Management. “But we think with about 4% yield It’s starting to look like a better entry point, particularly if there’s stability in the Treasury market.”
King also said other positive signs have emerged in the form of a pick-up in overnight buying activity by Asian investors in high-grade corporate bonds.
“That has definitely supported our market,” King said, though he is also concerned about rising hedging costs that could dampen foreign appetite. “If the Fed ends up raising rates by 50 basis points in multiple meetings, those hedging costs get more expensive.”
The path of inflation is everything
A big focus going forward will be the path of inflation, after the US. consumer prices rose 8.5% year over year in March, the fastest pace since January 1982.
David Norris, head of US credit at TwentyFour Asset Management, sees hope in lower prices for used cars and other segments of the consumer price index, but also in possible greater stability with the rate. 10-year Treasury bond around 2.7%.
“At the end of the day, I think we’re close to peak inflation at 8.5%,” Norris said by phone. While the Fed plans to anticipate rate hikes this year, it also expects that over the next two quarters the central bank will need to reassess the state of the economy, and perhaps decide that the policy rate will not need to be adjusted. aggressively higher.
“Over time, we’ll see how the economy is able to withstand rate hikes,” Norris said.
Brandywine’s McIntyre warned against unusual times. “It’s kind of a Volcker moment, and combine it with a Putin moment,” he said, referring to the rise in CL.1 oil prices,
and in other commodities following the Russian invasion of Ukraine and the early 1980s recession triggered by former Fed Chairman Paul Volcker’s battle against high inflation.
“Something is going to break,” McIntyre said. “Ideally, it’s inflation, so it means the Fed stuck landing.”