Investors bet on loans as Fed prepares to raise interest rates

Investors have rushed into funds buying U.S. loans over the past week, hoping to take advantage of higher interest rates as the Federal Reserve moves to tighten monetary policy to fight inflation.

Funds invested in US loans brought in $1.9 billion in the week to Wednesday, the biggest weekly addition to the asset class in five years, according to flows tracked by data provider EPFR.

The surge in the loan market came as the U.S. central bank prepares to withdraw pandemic stimulus and raise interest rates for the first time since December 2018. The Federal meeting minutes Open Market Committee in December showed policymakers could raise interest rates faster than previously expected.

Traders are betting the Fed will hike rates three to four times this year to around 1%, according to futures markets. That view on U.S. financial markets was bolstered by data showing rising employment and soaring consumer prices, cementing investor expectations of a hawkish change from the central bank.

“I think we may have reached the inflection point. The question is no longer “whether” rates will rise, but “how soon and by how much,” said Jeff Bakalar, head of the leveraged credit group at Voya Investment Management. “Each time this has happened, the loan market has become a safe haven.”

Loans are considered better protected against Fed policy change than corporate bonds because the coupon paid to investors rises and falls with benchmark interest rates. Interest on corporate bonds, on the other hand, is fixed and does not vary over time. This means that as interest rates rise, loan yields that accrue to investors also rise, while bond prices tend to fall.

The total return of a widely watched index of U.S. leveraged loans run by the Loan Syndications and Trading Association has risen 0.5% this year, pushing the average loan price to 99 cents on the dollar, its all-time high. over seven years.

Those returns eclipsed the performance of the benchmark S&P 500 stock index, which fell more than 2%, and high-yield corporate bonds, which lost 0.6% this year, according to Ice Data Services.

The recent volatility in financial markets, where investors reorganized their portfolios to adjust to higher interest rates, weighed on corporate bond funds. Funds that buy high-yield bonds saw redemptions of $1.6 billion over the past week, the first outflows since early December.

“Loans offer two features investors need in 2022 – rate protection and relatively stable performance,” Citi analysts Michael Anderson and Philip Dobrinov wrote in a report. “If the first week of 2022 is a harbinger of continued volatility, loans should be a compelling investment.”

Investors showed less interest in a segment of financial markets that has benefited from rising consumer prices over the past year: inflows into inflation-linked bond funds have fallen. The funds had about $40 million in inflows, down from $1.1 billion the previous week.

The modest addition indicates that despite December’s sharp rise in consumer price inflation reported this week, investors are confident in the Fed’s commitment to tighten monetary policy and rein in inflation. .

“The Fed appears more responsive to realized inflation impressions than it has in the past and stronger impressions appear to lead to expectations of more hawkish policy,” wrote Barclays analysts Michael Pond and Jonathan Hill in a note to clients. “If seen as credible and effective, discussions of tighter monetary policy should lead to lower inflation expectations.”

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