This week, a group of bond buyers and dealers issued a letter to the U.S. Treasury. The 'Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association' advised the Treasury to be careful as it moves to normalize short-term interest rates.
The letter (which is so laden with jargon, it was even hard for me to read) said, "The private sector piggy-backed on the Fed's large-scale asset purchases, a move that promoted a surge in corporate borrowing and tighter risk spreads. In this environment, a tail risk stress scenario is that a small increase in yields could possibly lead to large changes in risk premiums. In an adverse scenario, there's the possibility of a meaningful, but not systemically risky, decline in both credit and equities."
If I were to translate the committee's words, it would go something like this.
"The stimulative practices of the central bank (the Fed) were done to encourage risk-taking. The investment community has taken the Fed to heart, but now it's gone too far. At this very moment, money is chasing with wild abandon anything that will provide extra yield. Low quality bond issues (from less creditworthy corporations and emerging market countries) are flying out the door at remarkably low yields. In addition, bond covenants, that protect investors in the case of default, are being reduced or eliminated. So, while the Treasury is trying to prudently get its house in order so it's ready for the next economic downturn or market disruption, the industry is saying, don't be a party pooper."
OK, so I'm not much of a translator. But this warning is beyond ridiculous. Even though interest rate normalization is desperately needed, has been broadly telegraphed, and is well underway, bond investors can't pull themselves away from the punch bowl. They're hoping, once again, that the central bank will watch over them and make sure they get home safely from the party.
Note: At Steadyhand, we're taking a cautious stance toward corporate credit. The Income Fund has lightened up on corporate bonds and is focusing on higher quality issues. There's now only a modest position in high yield bonds. These moves have reduced the on-going yield of the fund, but our manager, Connor, Clark & Lunn, feels it's prudent to do so at this time.
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