Credit Investors Are Hoarding Cash

June has been the worst month for U.S. corporate bonds since the start of the pandemic by at least one measure, but investors like TCW Group Inc. and Voya Investment Management think it’s too soon to hunt for bargains.

Many credit investors are hoarding cash as the Federal Reserve tightens aggressively, having lifted rates this week by the most since 1994, with a goal of taming inflation. They’re hesitating to buy even after junk bonds have dropped 5.7 percent in June through Thursday, on track for their worst month since March 2020. Risk premiums on U.S. high-grade corporate bonds are climbing toward their highest levels in about two years.

“We’re not looking to add outright at these levels,” said Travis King, head of U.S. investment-grade corporates at Voya. The chance of a recession is rising, and current corporate debt prices don’t adequately reflect the risk, he said. His cash and Treasuries levels are 25 percent to 50 percent higher than normal.

More investors than usual seem to be similarly positioned. A Bank of America Corp. survey last month said that about 40 percent of money managers had above-normal cash levels in their high-grade portfolios—the highest percentage in at least a decade. In a separate study, U.S. corporate bond managers had nearly 3 percent of their portfolios in cash in May, near the highest levels since August 2021, according to preliminary data from Morningstar Inc. on mutual funds and exchange-traded funds (ETFs).

If investors are waiting for bigger bargains to arrive, corporate bonds may struggle to rally in the near term. Barclays Plc strategists said this week that credit markets don’t appear to have sufficiently priced in the slowdown in consumer spending growth that seems to be on the horizon.

Risk premiums on the bonds will likely reach as wide as 1.5 percentage point by the end of the year, the Barclays strategists said, compared with 1.44 percentage point on Thursday. Average spreads below 1.50 percentage point now feel too low, Voya’s King said. Voya had about $254 billion of assets under management as of the end of March.

Money managers’ high cash levels imply that money managers have been skeptical of the gains corporate bonds notched in late May. There’s other evidence of that skepticism, JPMorgan Chase & Co. strategists said in a June 10 note. For one thing, investors have been withdrawing money from high-grade funds: There have been 12 weeks of outflows, the longest such streak on record, Refinitiv Lipper data show. Also, bonds in the lowest tier of investment-grade hadn’t rallied enough through last week to indicate fears are disappearing, JPMorgan strategists said.

The fund outflows are a practical reason for money managers to keep higher cash levels: Keeping more liquidity makes it easier to manage investors’ redemptions.

“We are closer to maximum cash than normal,” said Bill Zox, a high-yield portfolio manager at Brandywine Global Investment Management. For that to change, “we’ve got to be convinced that the flows have stabilized.”

Markets have been moving sharply in recent days. These kinds of moves can create opportunities for investors willing to take risk.

Steve Kane, co-chief investment officer of fixed income at TCW, said he’s been adding slightly to his high-grade corporate bond holdings, but isn’t adding in high-yield, where more weakening is likely. He’s keeping extra dry powder on hand to be able to pounce on any “outlier-type events.”

Elsewhere in credit markets:

Americas

There are no new U.S. investment-grade bond sales on the calendar on Friday, representing the first time this year where no U.S. high-grade bonds were sold for the entire week.

• Spreads on U.S. junk-rated corporate bonds surpassed 500 basis points (bps) for the first time since November 2020.
• Average prices on leveraged loans fell to 93.67 cents on the dollar, also the lowest since November 2020.
• Citigroup’s legendary payment error to Revlon Inc. lenders will likely impede the cosmetic company’s bankruptcy plans, court papers show. The problem: It’s not clear who, if anyone, has the rights to the repayment of the remaining $500 million of loan principal caught up in the ongoing court battle over the accidental transfer.
• U.S. investment-grade bond funds have now seen 12 straight weeks of cash withdrawals, making for the longest outflow streak on record, Refinitiv Lipper data show.

EMEA

Primary markets are set for a third consecutive day without sales, which would bring the total for the year to 24, as credit conditions remain pressured by economic concerns. Meanwhile, issuance of covered bonds—one of the few resilient areas of sales—may begin to slow as the European Central Bank (ECB) ends its net asset purchases.

• Russia will push on with a plan to pay foreign bondholders in hard currency after the United States and European Union tightened sanctions before a deadline at the end of the month that could tip Russia into default.
• Bonds saw their biggest outflows since April 2020 last week, while investors bought equities, according to Bank of America strategists.
• Collateralized loan obligation (CLO) bankers are sitting on around 20 billion euros worth of deals because uncertainty over prices is keeping CLO managers from buying. Spreads on the top-rated portions of the industry have climbed 50 bps since February.

Asia

The Bank of Japan ran contrary to its U.S., U.K., and Swiss counterparts by holding firm with rock-bottom interest rates.

• Pockets of Japan’s bond market are imploding as the central bank battles to keep control of its policy goals and beat back those betting against it.
• In China, high-yield dollar notes were on pace to weaken for a tenth-straight day on Friday, matching a streak in May, amid building concerns in the global bond market. The country’s broader market was also poised for its seventh-consecutive weekly drop on a total return basis, according to a Bloomberg index

—With assistance from Paula Seligson & Caleb Mutua.

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