Federal 's strongest "eagle" of the year released by the Jackson Hall meeting not only affected global stock markets, but also tracked the total returns of investment-grade government and corporate bonds. The Bloomberg Global Aggregate Index (Bloomberg Global Aggregate Index), which tracked the total returns of investment-grade government and corporate bonds, also fell nearly 20% from its previous high, only one step away from falling into a bear market.
Which corner of the global bond market is the most dangerous? Some institutions including Goldman Sachs believe that the risk of (leveraged loan) in the United States is the most risky.
Global Bond Index is about to enter the bear
After the Federal Reserve clearly conveyed that it will continue to raise interest rates and will not rush to cut interest rates after hikes to a restrictive level, global bonds have encountered another round of selling, sliding towards the first bear market in a generation. The Bloomberg Global Comprehensive Index fell 19.3% from its previous record high in January 2021, and generally, a 20% decline from its previous peak will be considered entering the technical bear market . The MSCI Global Stock Index has also fallen by 16% so far this year. This situation of falling stocks and bonds has made the investment environment faced by global investors more and more difficult.
Kapstream Capital's portfolio manager in Sydney said: "Before the Jackson Hall meeting, our view was that the market began to price the Fed's interest rate cut too early, and Fed Chairman Powell's remarks on Friday reset market expectations. In addition, the impact of the situation in Ukraine and the pressure caused by extreme climate events have jointly driven the recent surge in energy prices, resulting in rising global cost pressures, which also put pressure on global growth and the central bank's monetary policy." Regardless, he said that the "dove" hopes that drove the summer rebound have been shattered, and the situation of bond investors is still in jeopardy.
Since the meeting last week, the Federal Reserve's "three leaders", New York Fed Chairman Williams, Cleveland Fed Chairman Mays Mess, and several senior Federal Reserve officials have made public speeches, echoing Powell's "hawkish" attitude.
On Wednesday, US bond yield continued to rise across the board. The 10-year U.S. Treasury yield rose by nearly 8 basis points and rose by 3.19%, setting a record high of two months. The 30-year long-term bond yield also rose by 8 basis points to 3.3%. The yield on the two-year U.S. Treasury, which is more sensitive to monetary policy, rose to 3.5% for the first time since 2007, hit a fifteen-year high.
At the same time, short-term bond yields are still significantly higher than long-term bond yields, highlighting the market's concerns about the decline. The 5-year/30-year U.S. Treasury yield has turned into an inverted reversal, with the 5-year yield closing at its highest since May 2008, with the increase in in August being the second largest monthly soar since November 2009. U.S. non-farm employment data to be released on Friday and the latest inflation data in two weeks will put bond investors at further risks.
In addition to hikes, Kozo Koide, chief economist at Tokyo-based asset management company One Co., warned that the Fed is accelerating its balance sheet reduction, which will also add more downward pressure on bond prices. At the same time, "because wages are growing so fast at present, even if the Fed will not publicly admit it, it is basically impossible to stabilize inflation at around 2% without increasing the unemployment rate and triggering a recession."
instead of just the Fed, from Europe to the UK to South Korea and New Zealand , many central banks conveyed the tough attitude of "interest rates will continue to rise at a certain rate" at last week's annual meeting of the global central bank. The market also quickly adjusted expectations, betting on the more radical ECB and Bank of England rate hikes, which led to the biggest monthly gains in decades in key European countries' government bond yields.
Goldman Sachs warns the risk of leveraged loans in the United States
So, in the view of analysts, which area of the global bond market is the most risky? Some institutions, including , Morgan Stanley, , have pointed their finger at US leveraged loans.
Morgan Stanley warns that as interest rates rise, this corner of the credit market may first "implosure". Srikanth Sankaran, a strategist at Morgan Stanley, said U.S. leveraged loans could be "canaries in credit coal mines" because they use floating interest rates and issuer qualifications are getting worse.With the U.S. economy slowing and the Fed hikes at its fastest rate in decades, these borrowers could be hit by double blows, namely, cash flow deteriorates on the one hand, and debt service costs rise on the other. The wave of downgrades is imminent and will continue into the coming quarters.
According to Wells Fargo Investment Institute, the term “leveraged loan” usually refers to senior secured bank loans issued by borrowers with credit ratings below investment grade. Usually, these loans are purchased by institutions such as investment bank , which then repackage leveraged loans of various levels into mortgage loans and sell them to investors. The era of low interest rates after the 2008 financial crisis led to the expansion of the leveraged loan market. Sangkaran cited data that by the end of June this year, the scale of outstanding leveraged loans had almost doubled compared with 2015, reaching US$1.4 trillion.
But many credit strategists expect this may soon reverse, as the Fed made it clear last week that interest rates will remain high for longer periods of time. Sankaran said that for this reason, investors should be wary of warning signs such as the "downgrade wave" of leveraged loans.
He analyzed: "Most of the issued leveraged loans are used by private equity companies to raise funds for company acquisitions, or simply refinancing. As the loan balance expands, the issuer's qualifications deteriorate. When the benchmark interest rate was previously maintained at 0% for a long time, this was not a big problem. But as interest rates rise, investors should pay attention to this area, because the qualifications of leveraged loan issuers are even far lower than junk bonds. Issuers. Currently, about half of junk bond issuers have credit ratings close to the highest BB level in non-investment grades, but only one-quarter of leveraged loan issuers have ratings of BB level, and the remaining three-quarters have even lower ratings. "He pointed out that the S&P /Cybersearch Loans and Trading Association Leveraged Loan Index only fell below 85 points during the worst period of the financial crisis in 2008 and the worst period of the selling caused by the epidemic in 2020. However, next, the index may fall below this level even if the U.S. economy experiences a "slight recession". However, he said that if leveraged loans experience a downgrade wave, it remains to be seen whether they will have a "snowball" effect on the entire credit market.
is not just Morgan Stanley, UBS also warned this week that the U.S. corporate bond market is currently seriously underestimating the risk of a recession.
UBS strategist Matthew Mish said in a research report on Tuesday that the current spread level of U.S. corporate bonds are included in the probability of a recession of 25%, while UBS predicts a recession of 55%. Although it has widened again recently, as of Monday, the overall interest rate spread of Bloomberg benchmark investment-grade corporate bonds was 138 basis points, still lower than the interest rate spread of 160 basis points on July 5; the overall interest rate spread of high-yield corporate bonds was 461 basis points, also lower than the 583 basis points on July 5. Mish expects that the spread of U.S. corporate bonds will return to the high levels that were once reached this year as the Federal Reserve further raises interest rates and slows economic growth.
A research report by Wells Fargo Investment Research Institute's strategist team this Tuesday also reminds investors to invest in leveraged loans with caution. However, the team added that the "implosure" of leveraged loans is not inevitable and still maintains a "neutral" judgment on leveraged loans. One reason is that from now until the end of next year, only 9% of outstanding leveraged loans will expire. Moreover, as the Federal Reserve continues to raise interest rates this year, demand for new leveraged loans has also declined. According to Bank of America , the value of newly issued leveraged loans has been below $200 billion since the beginning of this year, down about 57% from the same period last year.
