(Bloomberg) — Bryan Whalen, whose TCW Group fixed income team oversees more than $170 billion, warns that credit markets will likely face a correction after investors flock to corporate debt.
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“We think the pricing is completely inconsistent with the potential risks, and we think at some point this calendar year you’re probably going to have a countdown in the credit market,” Whalen said Friday on Real Yield from Bloomberg Television. “Everything is not as rosy in the economy as we would like to believe.”
The slowdown in U.S. job growth in April underscored how difficult it is for investors to time the market. Bonds broadly rallied after the government said the unemployment rate rose unexpectedly, signaling that demand for workers was starting to moderate.
Yields on two-year Treasury notes, which had topped 5% a few days earlier, fell to around 4.8% by midday as investors began to weigh the possibility that the Federal Reserve would begin cutting bond rates. interest from September. But a weaker economy increases the risk of losses on investment-grade and high-yield bonds if companies face a downgrade or outright default. Corporate debt could also lose value if prices prove to have been propped up by excessive investor exuberance.
Expectations of a possible drop in interest rates have boosted demand for U.S. corporate debt in 2024, pushing investment-grade bond spreads to their lowest levels in years on average. Billions of new high-yield debt securities also flooded into the market as investor appetite remained strong. Yet yields on U.S. investment-grade bonds have fallen about 2.2% this year, while yields on junk bonds have been just 0.95%, according to Bloomberg indexes.
“Picking the right month when the Fed actually goes away is not the right part of the analysis. The question is, what will the state of the world be, what will happen with inflation, what will happen with growth when they actually start cutting interest rates? Whalen said. “We are seeing a slowdown throughout the economy.”
A stock market rally in 2024 keeps spending and consumer confidence high, Whalen said, but Americans are spending on credit cards and dipping into their savings. This type of feeling can “transform in an instant,” he said.
A weaker economy increases the risk of losses on investment-grade and high-yield bonds if companies face a downgrade or outright default. Corporate debt could also lose value if prices prove to have been propped up by excessive investor exuberance.
“History suggests that by the time the Fed actually starts cutting interest rates, the economy is on a downward trend, it has gained downward momentum,” Whalen said. “It is more likely than not, in our view, that the Fed will need to act more aggressively once it finally begins to act.”
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