Credit Investors Are Hoping for Fed Pullback With Easy Money Hiding Risk

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.