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Last week, investors snapped up shares of funds that buy U.S. loans, expecting to profit when the U.S. Federal Reserve begins raising interest rates this spring, a move that will come sooner than many had expected until recently.
The funds collected $1.9 billion in new money last week through 12 January, their largest haul since 2017, according to data service EPFR.
Futures markets have priced in three or four rate hikes this year, betting that the Fed will end the year with a 1-percent base rate.
“The question is no longer ‘if’ rates will go higher, but how soon and by how much,” Jeff Bakalar, head of leveraged credit at Voya Investment Management, said to the Financial Times.
“Every time this has happened, the loan market has become a safe harbor,” he pointed out.
Loans are seen as safer than corporate bonded debt as the Fed raises rates because investors’ returns on loans fluctuate with interest rates, while bonds have a fixed rate of return.
As interest rates rise, so do loan values; in contrast, bond prices tend to fall.
The total return for the Loan Syndications and Trading Association’s loan fund is up 0.5 percent this year as of 14 January, hiking the price of loans to 99 cents on the dollar, their highest in more than seven years, ICE Data Service reported.
In contrast, the S&P 500 has shed 2 percent this year and corporate junk bonds have cast off 0.6 percent, according to the FT.
Funds that focus on high-yield corporate bonds, rated as junk, watched investors extract $1.6 billion from them last week, their first net outflow since 1 December.
“Loans provide two much-needed characteristics for investors in 2022—rate protection and relatively stable performance,” Citi analysts wrote in a new research report.
“If the first week of 2022 is a harbinger of persisting volatility, loans should be a compelling investment,” the report said.
TREND FORECAST: In “Risky Companies Snapping Up Cheap Loans” (23 Feb 2021), we said the junk bond and leveraged loan markets are gamblers’ games and many of their bets will come up craps when interest rates rise.
Those gamblers are now cashing out their chips.
Also, we maintain our forecast made in “Will Junk Bonds Turn to Junk?” (14 Dec 2021): now that the Fed seems ready to end its bond purchases and raise rates even sooner, junk bonds’ price slide will become steeper through the weeks ahead.
Junk bonds will be among the earliest casualties of the market reversal set off by higher interest rates and among the last to recover.