Worst January Ever for Junk Bonds Shows Fed’s Surprise Impact

(Bloomberg) -- U.S. junk bonds just posted their worst start to a year ever, and their dour performance last month made them a potentially surprising victim of the Federal Reserve's looming rate-hike campaign.

The Bloomberg U.S. Corporate High Yield Bond Index lost 2.73% last month on a total return basis, the biggest January decline on record and the worst month of any kind since the pandemic rocked markets in March 2020.

Junk bonds are considered less sensitive to tighter central bank policy than investment-grade debt. And, to be sure, junk did have a better January than the 3.37% plunge experienced by U.S. high-grade debt. But that's little comfort to high-yield investors now eyeing substantial portfolio losses.

The highest-quality part of the junk-bond market, BB rated debt, bore the brunt by falling 3.29%. Among sectors, food and beverage saw the steepest loss at negative 4.18%, according to data compiled by Bloomberg.

For some money managers, this is an opportunity to scoop up what they see as relatively safe bonds at a discount -- a view that hinges in part on believing uncertainty about the Fed's policy path is largely over. That might be a stretch, especially as traders consider the possibility the first hike could be 50 basis points instead of the usual 25.

“Last week was the first time when we felt the recent equity volatility trickle down to fixed-income markets and create some opportunities to deploy capital,” said Christian Hoffmann, portfolio manager at Thornburg Investment Management. “But it's far too early to load the boat given continued interest-rate volatility and a default rate that will only get worse from here.”

Risk premiums on U.S. high-yield debt, meanwhile, jumped the most in January since the onset of the pandemic, and some money mangers think that can go further. When these so-called spreads widen, it's a signal the overall market is weaker.

“I think spreads continue to widen over the next couple of months, although I'm sure it will be pretty volatile,” said Hunter Hayes, portfolio manager of the Intrepid Income Fund at Intrepid Capital Management. He's selectively adding to shorter-duration credits and likes commodities companies.

While the primary market has held relatively steady, signs of weakness are beginning to emerge as junk-bond issuers struggle to find buyers.

ION Analytics postponed its cross-border deal last week, becoming the first shelved issue in Europe since late November. Covis Pharmaceuticals Inc., meanwhile, added a number of sweeteners Monday to its $900 million junk-debt sale, signaling tepid demand from investors amid increasing market volatility. Bankers are still forging ahead though with buyout financings for McAfee Corp. and Scientific Games Lottery.

Elsewhere in credit markets:

Americas

Early pricing discussions on McAfee Corp.'s $3.3 billion two-part junk bond deal have increased amid market volatility that's also derailing sales in Europe.

Companies in the U.S. leveraged loan market easily topped expectations calling for $50 billion of sales and brought about $80 billion to the market, 58% of which went toward M&A, according to data compiled by Bloomberg
Pacific Life Insurance Co. is the latest U.S. company looking at the Canadian bond market as a regular source of funding
JPMorgan Chase & Co. has revised its forecast for AAA CLO spreads this year to 110bps over SOFR from 120 bps, arguing that a hawkish Fed will push demand for floating-rate products
For deal updates, click here for the New Issue Monitor
For more, click here for the Credit Daybook Americas

EMEA

A bumper deal from Goldman Sachs Group Inc. led Europe's primary market on Tuesday, as February kicked off with a steady flow of issuance.

Meanwhile, junk bonds are increasingly adopting some of the lax terms from the loan market -- a trend investors say signals a deeper erosion in credit standards
UBS Group AG increased its share buyback program and upgraded key profit and efficiency targets, boosting Chief Executive Officer Ralph Hamers after the bank was hit by a $740 million fourth-quarter charge related to a French tax case

Asia

Much of the region is observing the Lunar New Year holiday on Tuesday. Asia's primary market for dollar bonds got off to a quiet start of the week on Monday ahead of a shortened trading week.

India's Finance Minister Nirmala Sitharaman will outline the nation's budget on Tuesday, an occasion when officials in the past have unveiled regulatory changes to support overseas fund-raising or alter bond-issuance rules
Nomura Holdings Inc. said third-quarter profit fell 39% after the firm's trading business posted lackluster results, adding to signs that the heightened market activity spurred by the pandemic is abating