Fed tightening: debt investors bet on high yields and a soft landing- Newshubweek

Fed tightening: debt investors bet on high yields and a soft landing
Written by Arindam

To understand the significance of the US central bank’s latest message, do not focus on Fed chair Jay Powell, but Charif Souki. Souki is a former restaurateur turned energy pioneer. His latest venture, Tellurian, is attempting to build a liquefied natural gas terminal in Louisiana. It is a seemingly timely venture given global demand.

Tellurian had been seeking to raise $1bn through a junk bond offering. This week, Souki pulled the deal as a result of weak demand. This despite Tellurian offering a coupon of more than 11 per cent plus stock warrants.

Last year, junk bond yields fell below 4 per cent. Virtually any risk seemed able to find reasonable financing. Times have changed. Attempts to fully crush persistent inflation are the central bank’s priority. While raising benchmark interest rates by 75 basis points, the Fed said this week that the Federal Funds Rate could be higher than 4 per cent by the end of 2022.

The benchmark 10-year Treasury yield now sits well above 3 per cent, a level not seen since before the global financial crisis. Still, the US economy seems resilient. Unemployment is still low. Several sharp-eyed investors have noted that seemingly safe investment grade bonds are now offering yields in the recently unheard of range of 5 to 7 per cent. They prefer that bargain to double-digit coupons on a speculative energy project.

A so-called “soft landing”, in which the Fed avoids recession and regains overall price stability, is the bet. The Fed has indicated that it is worried about a job market that is too tight that pushes up wages to levels disconnected from worker productivity gains. But tech companies such as Snap have already implemented big job cuts. Reductions are looming at larger companies such as Meta too.

The high coupons on loans and bonds that are enticing some funds to bite cannot, however, compensate for eventual defaults. According to data from S&P, the dollar value of global corporate defaults reached nearly $30bn in the second quarter. This is triple the volume in the first quarter.

It has been 15 years since a sustained volatile market and monetary tightening combination. A generation of traders and investors are experiencing an entirely new rollercoaster ride. This youthful cohort is about to grow up fast.

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