Salient to Investors:

Stephen Antczak et al at Citigroup said:

  • Each of the 5 times since 1980 that the Fed started raising its benchmark rate, the extra yield on corporate bonds over government debt narrowed in the following 6 months as accelerating growth boosted optimism.
  • Spreads will tighten this time also, but after 6 years of short-term rates near zero and nontraditional forces at play, a flight by yield-seeking “tourists” could outweigh any benefits, and prevent or diminish the normal pattern of spread tightening.
  • Going back to 1988, in the 11 periods when the 10-yr T-yield rose more than 1% over a short period of time, the median spread on investment-grade bonds has typically tightened 0.31%, and on junk-rated debt by 1.08%.

Julian Robertson at Tiger Mgmt said the bubble in bonds will end in a very bad way.

Rick Rieder at BlackRock said the Fed’s statement last week offered signs that the pace of policy rate hikes is going to be quicker than markets have expected.

Much of the money contributing to the market’s growth may not stay around when rates rise. TrimTabs Investment Research said that when the Fed first signalled it would start ending QE in 2013, US bond funds posted a record $61.7 billion of redemptions through one period last June.

In the 3 tightening cycles in the past 25 years that ended in 1995, 2000 and 2006, high-yield junk bonds provided positive returns.

Patrick Maldari at Aberdeen Asset Mgmt said any violent move in benchmark rates would force the market to be more sensitive to Fed policy since interest-rate increases are associated with economic strength, but he expects a gradual, engineered move in benchmark rates and is more focused on credit risk than interest-rate risk.

The yield spread on junk bonds over treasuries is at 1.74% versus a high of 8.96% during the credit crisis.

Collin Martin at Charles Schwab said this time could be different and we won’t necessarily see spread tightening.


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