The Pain Cuts Deep And More Is Coming

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The world of Fixed Income is being ravaged. Look left, look right, and we are getting the slicing sword of the Fed, and their plans to raise rates, shoved into our guts. The Fed’s battle against inflation is causing more pain than we have seen in decades, and I believe there is no end in sight. I repeat, ‘NO End in Sight.”

Treasuries -14.57% Year-to-Date

*Data according to Bloomberg

Here, I am expecting *5* handles soon, all across the Yield Curve, and then likely higher handles, as higher interest rates are pushed by the Fed, as their main answer to combating Inflation. Push a little, shove a little, and then push more.

Yee Haw!

In a recent Reuters interview, James Bullard, President of the St. Louis Fed, said that inflation had become “pernicious” and difficult to arrest, and therefore “it makes sense that we’re still moving quickly.” I remind Mr. Bullard of the consequences, of the collateral damage, as “Price Stability” is their mandate, and not Inflation. In my opinion Inflation is a subset of their mandate, which absolutely calls for them to look at the economy, the markets, and the Dollar as part of their considerations. Unfortunately, however, that does not seem to be happening.

Then let’s consider the Fed’s effect on the Investment Grade Corporate Bond Market.

IG Corporates -20.29% Year-to-Date

*Data according to Bloomberg

Here it is not just what has happened to the bond holders but also what is happening to the corporate bond issuers. Much less issuance. You can count on that. Then the cost of refinancing is heading through the roof causing declines in both corporate revenues and profits. This will also have a major effect on their valuations, and on their stock prices, as the costs of any new borrowings, for any reason, head solidly skyward. Here is collateral damage of a very real kind and yet the Fed seems to be paying no attention at all, at all, to the consequences of their actions.

The Corporate High Yield market is also taking it on the nose.

HY Corporates -14.03% Year-to-Date

*Data according to Bloomberg

Here you can expect larger and more disastrous consequences. It will not just be an erosion in revenues and profits but also significant ratings downgrades, in my opinion, and then a slew of bankruptcies. In fact, High Yield borrowers that tapped the market in October have paid an average all-in yield of 12.25%, according to LCD data, which is the highest since March 2009. On an annual basis, the last time double-digit deals accounted for this large a share of high-yield issuance was in 2010, as the markets recovered from a global economic meltdown. In addition to the handful of M&A deals currently in the works, a number of borrowers have costly pandemic-era debt to refinance and will be waiting for those windows of opportunity. Per the Morningstar US High Yield Index, there are 14 borrowers with just over $6 billion of bonds coming due in 2022 and 2023 where many, if not most of the issuers, will need refinancing.

Then in the U.S. MBS markets we are watching mortgage rates climb through the proverbial roof.

MBS -15.75% Year-to-Date

*Data according to Bloomberg

In what was an especially turbulent past month, the MBS market recorded back-to-back underperformances for the first time all year. September fared its worst of 2022, and the worst of all time, besting July 2003’s great Refi wave (-153bps) and October 2008’s GFC (-163bps). Federal Reserve interest rate hikes and concurrent global central bank moves have rallied the U.S. Dollar, destroying all else in its path. MBS prospects for forward mortgage rates are higher and spreads move wider, in my opinion. This market is just a mess.

Finally, there is the Municipal Bond Market.

Municipal Bonds -11.41% Year-to-Date

*Data according to Bloomberg

Spreads are widening. Yields are going up. This will put a tremendous amount of stress on Municipal issuers, regardless of ratings, in my estimation. With higher yields, I can see a hike in taxes, in many localities, as the money is needed to pay their debts and keep their ratings. So much for holding down our Inflation rates.

After considering all of this, safety just lies in a very few places now. In my view those are very short maturities, floating rate bonds, and step-up bonds. Fixed rate securities are going to have a tough time in the months and maybe years ahead. A Fed change of course, or pivot, may certainly help but I am not of the opinion that either will be happening any time soon.

Original Source: Author

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.



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