Investors are pouring a large amount of funds into corporate bonds, and the risk premium is gradually tightening, while the Fed's rate cut has reignited hopes of avoiding a recession in the United States. At the same time, some fund managers have expressed that the current market is overly complacent about the worrisome factors.

Simon Matthews, Senior Portfolio Manager at Neuberger Berman, said, 'The upcoming US presidential election, coupled with the weakest expectations for German economic growth since before the COVID-19 pandemic, has left consumers feeling tight on cash, while Chinese economic growth is slowing down. When you consider all these factors together, it doesn't suggest that credit spreads should already be close to their upper limits.' He added that the cost of borrowing will decline, which will help alleviate some negative factors.

Investors have been shelving potential negative factors and delving into the riskiest areas of credit to seek higher yields. The lowest-rated bonds are currently outperforming the overall junk bond market, and there is expected to be increased demand for additional Tier 1 bonds that could force investors to incur losses to help banks navigate the turbulence.

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

However, Hunter Hayes, Chief Investment Officer at Intrepid Capital Management, said that if consumers start increasing their spending as interest rates decline, inflation may start to rise again. He said, 'Who knows, maybe the federal funds rate will return to a cycle of inflation as it did before, and all of a sudden, the appeal of high yield bonds will diminish.'

BlackRock analysts Amanda Lynam and Dominique Bly wrote in a report that market participants are also concerned about signs of deteriorating fundamentals, especially for borrowers with floating rate bonds, as the US monetary policy is likely to remain restrictive. In addition, issuers with a CCC rating continue to face pressure overall, despite the recent strong performance of their bonds.

They pointed out that the overall profit level of these companies is lower compared to interest expenses. The borrowing costs of CCC rating companies are still around 10%, which is a heavy blow to some small companies that need to refinance after the end of loose monetary era. Even if interest rates decrease, they still have default risk.

Morgan Stanley analysts, including Eric Beinstei and Nathaniel Rosenbaum, wrote in a research report last Monday that any weakness in the labor market will be "disadvantageous to interest spreads as it will increase concerns about economic recession and reduce yields."

One thing that can be certain is that valuation concerns remain moderate, and investors have largely increased their holdings of corporate bonds. Analysts at BNP Paribas wrote in a report that the start of an interest rate reduction cycle is expected to provide more support for non-cyclical bond demand in the investment grade market than for cyclical bonds.

They added that the limited issuance of healthcare companies and utility companies provided room for spread compression.

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

Editor/Rocky