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By Caleb Mutua and Jack Pitcher
(Bloomberg) — Bob Michele, a bond market veteran with decades of experience, will shelter in short-dated investment grade bonds in the coming downturn.
“I’m certain we are headed into a recession and high quality fixed income will be that anchor in the storm; that flight to quality, the safe haven that everybody will be looking for,” Michele, JPMorgan Asset Management’s chief investment officer, said on Bloomberg TV on Wednesday.
For the US high yield market, he expects the pain will only worsen as an economic decline edges closer.
With a 75-basis-point interest rate hike widely expected Wednesday afternoon New York time, the focus of the Federal Open Market Committee meeting this week will be whether Federal Reserve chair Jerome Powell signals a downshift in the pace of rate hikes ahead. Businesses and households having such strong balance sheets is a reflection of low unemployment, which means the Fed will continue raising rates.
“The Fed is telling you things are going to get pretty bad,” he said.
Higher rates have hurt returns for debt investors across the credit ratings spectrum this year. Investment-grade corporate bonds, which are more sensitive to interest rate moves given their higher duration, have dropped more than 19% this year and are on pace for the biggest annual loss ever. But Michele expects the repricing in that credit-worthy corner of the market is almost over, and sees opportunities in shorter term — less than two years — investment-grade corporates and short securitized credit. He’s also taking a more favorable view on its longer-dated debt.
“For the first time in a couple of years I’m actually looking to buy high quality, long duration assets,” said Michele. “Then I’m going to wait.”
The repricing in the junk market, meanwhile, is only about one-third of the way done, he said. Average junk spreads ended Tuesday at 447 basis points and Michele expects the risk premiums to peak in the middle of a recession at around 800 basis points to 1,000 basis points. While the index is “marginally better” from a quality perspective, there’s been a tremendous amount of funding in the debt market to low-quality companies and much of that is in the private credit markets and illiquid, he added.
“And guess what’s going to be the relief valve to investors that want to do risk in private credit? It’s going to be the public market,” said Michele. “It always is.”
Borrowing costs are also skyrocketing as the central bank jacks up rates, making it harder for issuers to raise new capital. Risks are rising across the credit spectrum, with defaults likely to accelerate and liquidity to remain scarce as the era of benign credit conditions nourished by low interest rates and abundant liquidity comes to an end, Moody’s Investors Service said in a note Wednesday.
“The markets are priced for a soft landing,” he said. “They are not priced for a recession. We’ll know when they are priced for a recession when credit spreads start blowing out,” he said.
–With assistance from Jonathan Ferro.
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- Fed’s yield-curve barometer starts flashing recession risk
