Credit Market Risk Eases as Powell Quells Future Rate-Hike Fears

Olivia Raimonde, Michael Tobin and Samantha Stewart, Bloomberg News

, Bloomberg

(Bloomberg) -- Credit traders took some comfort in Federal Reserve Chair Jerome Powell’s assurances that the central bank isn’t planning to lift interest rates further, sending a gauge for fear of corporate defaults to lower levels.

The Federal Open Market Committee unanimously decided on Wednesday to hold interest rates steady for the sixth consecutive meeting, as anticipated. While a series of higher-than-expected inflation readings spurred traders to dial back wagers of rate cuts later this year, Powell isn’t expecting further rate increases.

“It’s unlikely that the next policy rate move will be a hike,” Powell said in a press conference Wednesday.

The spread on the Markit CDX North American Investment-Grade Index, which tracks price changes in the credit default swap market, tightened as much as 1.89 basis points to 51.932 basis points, before widening slightly. The narrower the spread, the less expensive it is, on average, to insure bonds against default.

READ: Stocks Join Gains in Bonds After Fed Decision: Markets Wrap

Markets interpreted Powell’s speech as less hawkish, but policymakers were clear that while inflation has moderated, it is still too high for the committee to be certain about its path forward without more data.

“Inflation is still too high, further progress in bringing it down is not assured, and the path forward is uncertain,” Powell said Wednesday. “We are fully committed to returning inflation to our 2% goal. Restoring price stability is essential to achieve a sustainably strong labor market that benefits all.”

READ: Fed Cites Lack of Progress on Inflation, Holds Rates Steady

The average spread on blue-chip bonds — the premium over Treasuries investors demand to hold such debt — was 87 basis points Tuesday, after tightening five basis points the week prior.

The drop in risk premiums is being driven by relentless demand for corporate bonds from investors as issuance tapers after borrowers sold a record amount of new debt in the first quarter. Roaring appetite and a slowdown in supply are helping keep spreads tighter even as rate volatility escalates and the outlook for the US economy grows murkier.

For risk premiums to go sustainably higher there would need to be suggestions about rate hikes from the Fed, according to Viktor Hjort, global head of credit strategy and desk analysts for BNP Paribas.

“Rate hikes are bearish, because it opens up a new scenario of uncertainty, and it’s impossible for markets to know where that path ends,” he said. “For sure a hard-landing risk becomes much higher then.”

Interest rates staying higher for longer have actually helped keep demand for credit strong, and many investors believe that a delay in rate cuts amid still positive economic growth is a supportive enough backdrop for tighter credit spreads.

“The ingredients for higher for longer are actually, in some ways, supportive of a healthier corporate-bond market,” said Hunter Hayes, portfolio manager at Intrepid Capital Management. “There’s probably also an expectation of rate cuts embedded in spreads, which are keeping them tighter than they otherwise would be.”