Relentless US credit demand seen driving Q2 rally

WASHINGTON, Apr 01 (Reuters): An investor scramble to lock in returns before the Federal Reserve cuts rates is expected to sustain a rally in the US corporate bond market into the second quarter, with one strategist saying it may touch levels not seen in three decades.
Credit markets are being overwhelmed by a buying frenzy, as investors bet the Fed will engineer a soft landing, taming inflation without causing a recession, and then cut interest rates later this year to support growth.
On March 21, the premium paid by companies over Treasuries, called credit spreads, on investment grade rated and junk-rated bonds touched their tightest levels in two years - at 91 basis points and 305 basis points, respectively.
Large bond investors such as insurance companies and pension plans are seeing an influx of money from their clients looking to capitalize on higher interest rates, leading them to seek corporate bonds, credit strategists said. But there may not be enough new issuance to go around.
In the first quarter, for example, investment grade companies raised a record $538 billion - that's 40 per cent of the $1.3 trillion of bond supply that was expected for the entire year, according to data from research firm Informa Global Markets. In a sign of strong demand, new offerings have been three to four times oversubscribed on average.
Morgan Stanley's credit strategist Vishwas Patkar likened the current market to conditions in the mid-1990s, when after four cuts in 1995, the Fed kept rates high for an extended period of time. "Credit remained very resilient, and spreads hit their modern era tights of 56 basis points even as rates were higher," he said.
Patkar said there was a chance spreads could go as low as 75 basis points, levels not seen since the 1990s, if a soft-landing was achieved. Earlier this month, he moved his base case year-end spread target to 95 basis points from 125 basis points.
He's not alone. Bank of America strategists expect spreads to tighten to around 80 basis points over the next month, closer to the 77 basis point level touched in 2021. They are, however, sticking to a 6-month spread target of 100-120 basis points.