Stocks Weren't the Only Risky Assets Freaking Out After the Fed Hiked Rates
Photograph by Mark Wilson/Getty Images
A lot can happen in two hours.
In the window between the Federal Reserve's policy announcement and the close of trading, U.S. risk markets made their most violent single-session move in response to a rate increase since the central bank first started tightening policy in 2015.
The S&P 500 closed 1.5% lower, the biggest stock-market move on the same day as a rate increase this cycle.
Credit markets responded by pricing in a higher chances of corporate defaults over the next five years-for risky high-yield companies and safer investment-grade firms alike. The 5-year high yield CDX index's spread rose 16 basis points (or 0.16 percentage point), and the 5-year investment grade CDX's spread rose four basis points. That was also the biggest jump in spreads on the day of a Fed rate increase since 2015.
Rising spreads might seem reasonable, because higher rates make it more expensive for companies to pay interest on floating-rate debt. But most corporate bonds are fixed-rate, which means they are benchmarked to Treasury yields. And the 5-year Treasury yield actually fell, though just by one basis point.
To be sure, markets have had stronger responses to Fed decisions in the days following a rate increase. One day after the Sept. 26 rate increase, for example, high-yield CDX 5-year spreads rose 18 basis points.
But the timing of Wednesday's selloff matters, because it shows how fragile markets have become since global central banks (in Europe and Japan especially) started slowing the pace of their bond buying.
The logic is simple: When central banks stop buying bonds, the yields on bonds rise, which provides investors a place to earn safe returns. And when global investors can earn yield without sending money into risky or foreign markets, they keep their cash at home. That leaves those markets vulnerable to sharp changes in mood among the investors who remain.
Foreign demand for U.S. corporate bonds is falling, according to a recent note from Torsten Slok, strategist at Deutsche Bank. And Treasuries make up the largest share of the U.S. bond market since at least 1970, he wrote.
And with risk-free alternatives yielding more than 2%, it should come as no surprise if investors choose not to buy this dip when Thursday comes.
Write to Alexandra Scaggs at email@example.com