For the better part of a decade, credit investors like David Sherman have been waiting for the market to come back down to earth.
There was a taste of it in 2015 after oil prices collapsed amid the Federal Reserve’s first attempt to wean the market off of its massive balance sheet. And then it came awfully close to happening last year when Covid-19 sent the world into lockdown. But the Fed once again slashed interest rates and cranked up its money-printing machine, dodging an economic disaster and unleashing another mega rally in everything from stocks to corporate debt.
Now as Fed policy makers meet this week to begin the slow process of reducing its market support, the Shermans of the world are wondering if it will lead to the kind of market turmoil that presents opportunities to value investors like him, or if the world’s most powerful central bank has created a new normal.
“I think the question is can the Fed pull back?” Sherman, president at Cohanzick Management LLC, said in an interview. “The problem is the world has sort of gotten hooked.”
The Fed buys about $120 billion of Treasuries and mortgage-backed securities per month, and it purchased high-yield debt for the first time ever last year. That market support has helped drive junk-rated bonds to record-low yields while corporate borrowing has soared. At the same time, large bankruptcy filings this year have fallen below the 10-year average while the amount of debt trading at distressed levels in the Americas has evaporated after reaching its Covid-crisis high of nearly $1 trillion.
“The investment community has come to count on the fact that the Fed will ride in as quickly and forcefully as possible at the first sign of stress,” David Tawil, president and co-founder of Maglan Capital LP, said in an interview.
Federal Reserve officials didn’t respond to a request for comment.
Pull Back
Stabilizing the market last year helped reduce the broader economic impact from Covid. But as that recovery takes hold and consumer prices rise, investors expect the Fed will cut back its purchases by about $15 billion per month starting mid-November and ending by June.
That pull back would be welcome for restructuring professionals like Matt Warren, a partner at law firm King & Spalding, who’ve had few bankruptcies to work on and instead spent this year looking for potential pitfalls in private loans and high-yield bonds amid a borrowing frenzy.
“The credit markets are incredibly frothy, and they have been this entire year,” he said. “There’s so much money chasing a smaller sub-set of deals, the leverage shifts to the person needing the financing to increasingly dictate terms.”
That easy money has given investors like Jason Dillow less incentive to put cash in public markets, where he sees no protective measures for investors and yields that are too low. The willingness to accept those yields and few or no insulating covenants reflects broader complacency from investors that the Fed will always step in to save them, he said.
‘Moral Hazard’
“I think that’s the moral hazard around the next cycle,” Dillow, chief executive officer at Bardin Hill Investment Partners, said in an interview.
His firm has focused on providing financing to small and mid-sized companies in order to replicate the double-digit returns that Bardin Hill has seen in its opportunistic credit fund, he said. Having the flexibility to move between different types of investing depending on market conditions has been essential, Dillow said.
“If all you do is distressed, you had an awesome opportunity for 6 weeks last year,” he said.
Cohanzick’s Sherman has focused on providing financing to special purpose acquisition companies with fewer opportunities in traditional credit markets, he said.
As the Fed prepares to begin slowing bond purchases, it raises the question of whether the central bank has permanently altered markets in the course of preventing economic downturns.
“The Fed’s intervention is relatively new, but it is so embedded now that it has transformed the distressed market,” said Dominique Mielle, a former partner at credit hedge fund Canyon Partners and author of the hedge fund memoir “Damsel in Distressed.”
Elsewhere in credit markets:
Americas
Five companies are tapping the U.S. investment-grade corporate bond market on Tuesday as issuers rush to get ahead of Wednesday’s FOMC meeting. Deutsche Bank NY kicked things off overnight by announcing a two-tranche deal.
- This year’s gross high-grade new issue supply is now on pace to pass 2017’s $1.33 trillion for the second-biggest year on record after October volume surged past projections
- The high-yield primary market has lined up at least $5 billion, including two debut issuers, for the first week of November as investors continue their search for yield
- Endo International and Teva Pharmaceutical bonds were the best high-yield performers Tuesday morning in New York, advancing after the drug makers defeated a lawsuit by local governments in California that claimed they created a public-health crisis through misleading marketing
- U.S. Securities and Exchange Commission Chair Gary Genslersignaled he’s interested in leveling the playing field in the corporate bond market by making key pricing information available to more investors
EMEA
Ten issuers are offering at least 7.5 billion euros ($8.7 billion) of bonds in Europe’s primary market on Tuesday, after a blank Monday.
- Among the day’s deals, Teva Pharmaceutical Industries is expected to price the equivalent of $4 billion of sustainability-linked notes denominated in dollars and euros, after announcing price talk overnight
- ESG issuance has reached a record 25.99% of the 1.5 trillion euros of public deals in Europe so far this year, according to data compiled by Bloomberg
- Standard Chartered Plc sees revived growth next year as the economic recovery from Covid-19 brings likely interest rate rises
- The London-based lender said underlying pretax profit rose 44% in the third quarter to $1.08 billion, beating a company-compiled forecast, after a rise in trading income
Asia
A sharp selloff in China’s junk dollar bonds deepened Tuesday, with such notes falling at least 3 cents on the dollar, according to credit traders.
- Property developer Times China’s 6.75% note due 2025 fell 7.4 cents on the dollar to 65.9 cents, on pace for the biggest decline in more than three weeks, according to Bloomberg-compiled prices as of 4:01pm in Hong Kong
- Yuzhou’s 8.5% 2023 bond dropped 5.8 cents to 40.3 cents
- Both are on track for 10th consecutive daily decline and fresh record closing low
- The selloff of China property developer debt has also been spreading in recent weeks to investment-grade giants, injecting volatility into what had been some of the most staid investments in the industry
- Spreads on high-grade Chinese dollar bonds have widened about 15 basis points from a 18-month low in September, according to a Bloomberg index
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Read more articles by Allison McNeely, Eliza Ronalds-Hannon
