The Fed's significant rate cut exacerbates valuation anxiety, prompting investors to flock to corporate bonds

According to the financial news app Zhitong Finance, investors are pouring a large amount of funds into corporate bonds, with the risk premium gradually tightening. The rate cut by the Federal Reserve has reignited hopes of avoiding a recession in the United States. At the same time, some fund managers have expressed concerns that the market is overly complacent about worrisome factors.

Simon Matthews, Senior Portfolio Manager at Neuberger Berman, said, "With the upcoming U.S. election and the weakest expectations for German economic growth since before the COVID-19 pandemic, consumers are feeling financially constrained, and Chinese economic growth is slowing down. When you consider all these factors together, it doesn't tell you that credit spreads should be close to their limits." He added that the decline in borrowing costs will help alleviate some negative factors.

Investors have been setting aside potential negative factors and delving into the riskiest credit areas in search of higher yields. The lowest-rated bonds are currently outperforming the overall junk bond market, and there is expected demand for Additional Tier 1 bonds that may force investors to incur losses to help banks weather the turmoil.

Buyers are betting that lower borrowing costs will allow heavily indebted companies to refinance and extend maturities, thereby limiting defaults and supporting valuations. With short-term interest rates falling, investors are expected to shift funds from the money market to medium to long-term corporate bonds, which could further narrow spreads.

However, Hunter Hayes, Chief Investment Officer at Intrepid Capital Management, said that if as rates decline, consumers start increasing spending, inflation may start rising again. He said, "Who knows, maybe the federal funds rate will return to a period of inflation like before, and suddenly, the attractiveness of high-yield bonds will take a big hit."

In a report, BlackRock researchers Amanda Lynam and Dominique Bly wrote that as U.S. monetary policy may remain restrictive, market participants are also watching for signs of deteriorating fundamentals, especially for borrowers holding floating-rate bonds. Additionally, issuers rated CCC still face overall pressure, despite the recent strong performance of their bonds.

They pointed out that these companies have lower overall profit levels compared to interest expenses. The borrowing costs for CCC-rated companies are still around 10%, which is a heavy blow for some small companies that need to refinance after the end of the loose monetary era, even with falling interest rates, they still face default risks.

Morgan Stanley analysts including Eric Beinstei and Nathaniel Rosenbaum wrote in a research report last week that any weakness in the labor market will "be unfavorable for spreads as it will increase concerns about an economic recession and lower yields."

It is certain that valuation concerns remain mild, and investors have largely increased their holdings of corporate bonds. Analysts at BNP Paribas wrote in a report that the start of a rate cut cycle is expected to provide more support for non-cyclical bonds in the investment-grade market than cyclical bonds They added that the limited issuance of healthcare and utility companies provided room for spread compression.

Megan Robson, head of US credit strategy at the bank, said in an interview: "This is an excellent opportunity for non-cyclical investors to outperform the market, while cyclical bonds are overvalued."