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Restrictive monetary policy, inflation pressures, recession fears – all these factors have sparked a perfect storm for the global debt market. No wonder the 2-year Treasury yield is trading above the US 10-year Treasury yield. Looking forward, the combined effect of high volatility and funding costs, amplified by leverage and concentration risk, could set off a so-called “liquidity spiral”.
Even U.S. Treasury Secretary Janet Yellen acknowledged that liquidity in the vast Treasuries market has diminished. To avoid the collapse of the monetary system, the SEC proposed new rules to improve resilience and transparency in the $5 trillion money market sector. On top of that, Treasury began to monitor hedge funds more closely to gain insight into their leverage and concentrated positions.
What else? According to Allianza, central banks could help address the adverse impact of the current pace of monetary tightening on market functioning by making securities lending more widely accessible. Widening collateral eligibility for accessing central bank money could also boost precious liquidity in corners of the capital market that are at risk of liquidity squeezes, such as corporate debt.
Is there anything else to worry about? Despite the previously described risks, greedy retail investors are buying junk bonds in hopes of softening the Fed’s rhetoric. For example, last Friday, inflows into the SPDR Bloomberg High Yield Bond ETF totaled $980 million. Banks, on the other hand, use this situation to get rid of potentially problematic bonds, whereas “fallen angels” try to raise more capital.
How long will the rally last? Analysts at JPMorgan Chase & Co believe the risks of investing in investment-grade loans outweigh the potential rewards. Barclays Plc, meanwhile, expects credit spreads to widen. Now it’s up to Mr. Powell. If the Fed chief goes along with the market and announces a slowdown in the rate hikes in December, a wave of optimism will affect not only the stock market but also the debt market.
