In his latest investment letter Markus Allenspach, Head of Fixed Income Research at Julius Baer comments that the Fed is comfortable with the current rate level and that most likely rates will stay unchanged throughout 2020 at the current target corridor of 1.50%–1.75%.
“According to the US Federal Reserve (Fed), the US economy and its monetary policy are in good shape. This means that further rate reductions are unlikely. After cutting the target rate corridor three times this year, the overwhelming majority of Fed officials seem to favor sticking to the current corridor of 1.50%–1.75%. We expect the Fed to keep rates unchanged at its next meeting on December 11 and throughout 2020. Financial market pricing implies that market expectations have converged towards this view but do not match it completely. Money market futures are still discounting another rate cut in the second half of 2020.”
Watch out for US high-yield energy issuers
Allenspach has a word of warning about for debt issuers from the energy sectors as current oil and natural gas prices are putting US high-yield issuers under stress.
“In the current environment of subtrend growth, the market is penalizing weak issuers mainly in cyclical sectors, demanding higher spreads in order to provide funding. Spreads for Caa rated issuers are now back to 2016 levels, a picture that does not hold true for Ba or B rated issuers.”
“Our chart shows the situation in the US energy sector. Historically, there had been a negative correlation between the oil price and credit spreads. In other words, when oil prices went down and the profit outlook worsened, energy issuers had to pay higher spreads, and vice versa. The negative correlation has weakened as of late, with the oil price staying stable while spreads of US speculative-grade energy bonds are widening. Taking a closer look, we find that the market is penalizing pure natural gas players, whose balance sheets have weakened and who cannot be as competitive as the bigger oil players. The latter are drilling for oil and exploring shale natural gas as a by-product, which they use to swamp the gas market. As supply drove natural gas prices lower, pure natural gas players saw a deterioration in their credit metrics, causing the market to shun away from them both in terms of their bonds and their equities. Year to date, 19 Moody’s-rated issuers in the energy sector have defaulted and we expect to see the default count increase as refinancing becomes scarce.”
“We stay cautious in cyclical sectors and in energy in particular. Investors in high-yield energy issuers should reassess their exposures and select issuers with solid balance sheets and positive free cash flow generation, who can survive in the current low oil-price environment.”