Mon. Jan 24th, 2022

Investors stormed into funds buying U.S. loans in the past week, hoping to take advantage of higher interest rates as the Federal Reserve prepares to tighten monetary policy to curb inflation.

Funds invested in U.S. loans pulled in $ 1.9 billion in the week to Wednesday, the largest weekly addition to the asset class in five years, according to flows tracked by data provider EPFR.

The push in the loan market came as the US Federal Reserve prepared for it pandemic stimulus withdrawn measures and raise interest rates for the first time since December 2018. Minutes of the Federal Open Market Committee meeting in December has shown that policymakers can raise interest rates faster than previously expected.

Traders bet the Fed will raise rates in between three and four times this year to about 1 percent, according to futures markets. This view in US financial markets has been reinforced by data showing rising employment and rising consumer prices, which confirms investors’ expectations of a falconry shift from the central bank.

“I think we may have reached the turning point. The question is no longer ‘whether’ rates will rise higher, but ‘how soon and by how much’, ”says Jeff Bakalar, group head of leveraged credit at Voya Investment Management. “Every time that happened, the loan market became a safe haven.”

Weekly Flow to US Loan Fund ($ billion) Bar Chart showing US loan funds' largest inflows in five years

Borrowing is considered better isolated from a Fed’s policy shift 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 change over time. This means that as interest rates rise, the yield on loans that flow back to investors also increases, while bond prices tend to fall.

The total yield on a widely viewed index of U.S. leveraged loans managed by the Loan Indications and Trade Association is 0.5 percent higher this year, bringing the average price of the loans up to 99 cents on the dollar, the highest level in more than seven years.

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

Recently volatility in financial markets, where investors rebuilt portfolios to adjust for higher interest rates, corporate bond funds weighed. Funds that buy high-yield bonds have suffered repayments of $ 1.6 billion in the past week, the first outflow since the beginning of December.

“Loans provide two much-needed features for investors 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 sustained volatility, lending should be a compelling investment.”

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

The modest addition indicated that despite the sharp rise in December consumer price inflation reported this week, investors have confidence in the Fed’s promise to tighten monetary policy and curb inflation.

“The Fed seems more sensitive to realized inflation prints than it has been in the past, and stronger prints appear to lead to expectations of more falconry policies,” Barclays analysts Michael Pond and Jonathan Hill wrote in a note to clients. “If seen as credible and effective, talk of tighter monetary policy should lead to lower forward inflation expectations.”

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