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The Yield Curve Is Warning Investors to Exit Bank Loans, Citi Says


image Photograph by Etienne Boulanger

Citigroup is warning investors against chasing the rebound in the leveraged loan market. The shape of the U.S. yield curve should act as a red light.

The leveraged-loan market has staged a sharp rebound from a bad month, and its worst month of investor outflows on record. The outflows have slowed since then, and the market's performance has improved: Jan. 4's strong employmen t report fueled the third-biggest single-day price gain in the loan market since at least 2007, according to a Thursday note from Citi strategists Michael Anderson and Philip Dobrinov. Leveraged loans have returned 3.25% in the first six days 2019.

But there's a big caveat to all of this good news-besides all the regulator concerns about quality that Barron's has covered previously.

Investors generally buy into bank-loan funds, which invest in leveraged loans, because their yields rise when U.S. interest rates do. But the bond market is signaling that the Federal Reserve's December rate increase could be its last for this economic expansion. Market prices indicate that the central bank could start cutting rates as soon as 2020, as Barron's has recently noted.

That means the market's prognosis is even more dire than it was in the first half of December, when the prospect of a yearlong pause in rate increases helped start the loan-market selloff.

If the central bank is actually finished raising rates for good, there is even less reason for investors to own bank-loan funds.

"If the Fed has already hit its terminal rate," or its peak policy rate, "we will begin the countdown to rate cuts," Anderson and Dobrinov wrote. "The shape of the curve is warning investors to cut their floating rate exposure."

Write to Alexandra Scaggs at alexandra.scaggs@barrons.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





This article appears in: Investing , Investing Ideas



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