In One Chart: Junk bonds could see more volatility as the Fed starts pulling away its ‘safety blanket’ of monetary support, says Deutsche Bank
It has been one of the calmest years on record for the roughly $1.6 trillion U.S. high-yield, or “junk-bond,” market, according to Deutsche Bank.
“A perfect calm of the strongest growth for decades, coupled with still extreme levels of stimulus has resulted in very low spread ranges,” Deutsche Bank’s team led by Jim Reid, head of thematic research, wrote in a 2022 credit outlook Monday.
Spreads are the premium investors are paid to own certain bonds above risk-free benchmarks to help compensate for default risks. For “high-yield”
bonds, often issued by cash-burning or debt-laden U.S. companies, that rate was last at about 324 basis points above Treasurys
near post-2008 lows.
However, the Deutsche team expects low volatility to become more scarce in the coming year, particularly if the Federal Reserve and other global central banks act as expected and start removing their “safety blanket” of monetary support.
That’s largely due to the “scale of the Covid global QE,” according to the analysts, who put together this chart showing the impact on U.S. junk-bond spreads
in “various phases” of quantitative easing, or large-scale asset purchases by central banks, in the past.
Tracking QE, credit spreads over the past 13 years.
Deutsche Bank, Bloomberg, Federal Reserve
“In terms of taper or rate hikes, the evidence of the last 13 years is not that conclusive in terms of its impact on credit spreads,” the team wrote. But they also said there is a “chance of more volatility for next year, especially if it opens the way for a more aggressive Fed than the market expects.”
Bank of America recently tallied the balance-sheet growth of six major global central banks, from the Fed to the People’s Bank of China, since 2008. The total is nearly $30 trillion, but is forecast to slightly recede next year.
Combined balance sheets of six major central banks nears $30 trillion.
President Joe Biden on Monday nominated Jerome Powell to head the Federal Reserve for a second four-year term, saying it would bring stability to the central bank during the U.S. economic recovery from the pandemic. He also nominated Fed Gov. Lael Brainard for vice chairwoman, the No. 2 spot, with both picks requiring confirmation by the Senate.
The Fed plans to reduce its $120 billion monthly pandemic bond-buying program by $15 billion a month in November and December, but seeks to remain flexible on its pace of buying going forward.
U.S. stocks rose Monday to intraday records, buoyed by expectations of “continuity” in the Fed’s leadership, but the Nasdaq Composite Index
and S&P 500 index
ended in negative territory as Treasury yields climbed across the board. The Dow Jones Industrial Average
notched a modest gain.
Read: Here’s what Powell’s nomination for 2nd term as Fed chairman means for markets
“[W]e still think the economy and asset markets have enough residual stimulus to be well-supported as a whole, but without the constant fresh liquidity, the market will be more vulnerable to newsflow,” Deutsche’s analysts wrote.
Check out: What trades more in a day than most Dow stocks? It’s a big junk-bond ETF