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THE BIZNOB – Global Business & Financial News – A Business Journal – Focus On Business Leaders, Technology – Enterpeneurship – Finance – Economy – Politics & LifestyleTHE BIZNOB – Global Business & Financial News – A Business Journal – Focus On Business Leaders, Technology – Enterpeneurship – Finance – Economy – Politics & Lifestyle

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Fed’s Move to Tighten Liquidity Casts Shadow on the Euphoria in US Corporate Debt

Fed's Move to Tighten Liquidity Casts Shadow on the Euphoria in US Corporate Debt
Flags fly over the Federal Reserve building on a windy day in Washington, U.S., May 26, 2017. REUTER... Flags fly over the Federal Reserve building on a windy day in Washington, U.S., May 26, 2017. REUTERS/Kevin Lamarque/File Photo
Fed's Move to Tighten Liquidity Casts Shadow on the Euphoria in US Corporate Debt
Flags fly over the Federal Reserve building on a windy day in Washington, U.S., May 26, 2017. REUTER... Flags fly over the Federal Reserve building on a windy day in Washington, U.S., May 26, 2017. REUTERS/Kevin Lamarque/File Photo

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Fed’s Move to Tighten Liquidity Casts Shadow on the Euphoria in US Corporate Debt

As demand for top-rated U.S. corporate debt continues unabated, concerns are emerging among some investors who anticipate a potential selloff later this year if liquidity conditions deteriorate. The persistent search for yields amid high interest rates and optimism about the U.S. economy has led to record debt issuance by investment-grade-rated companies in 2024. Credit spreads, representing the premium companies pay over U.S. Treasury securities for issuing bonds, are currently at their tightest levels in years.

However, apprehensions in the market are growing as investors consider the vulnerability of the asset class to a repricing when the Federal Reserve tightens financial conditions. The concern centers around the potential impact of the Fed’s actions on bank reserves, which have remained abundant due to excess liquidity in the financial sector.

Inflows into the Fed’s overnight reverse repo facility, serving as a proxy for excess cash in the financial system, have been declining sharply over the past year. As cash drains from this facility, it is anticipated that bank reserves at the Fed will start to decrease, tightening overall financial system liquidity. This tightening could potentially affect the demand for risky assets, including stocks and credit.

Daniel Krieter, Director of Fixed Income Strategy at BMO Capital Markets, highlighted the observed relationship between the level of excess bank reserves and investment-grade credit spreads. These spreads tend to tighten when reserves rise. Some investors, such as Matt Smith, a fund manager at Ruffer, are anticipating a tightening of liquidity and are positioned for a potential sharp selloff, especially considering the current expensive valuations across markets.

Estimates regarding when the reverse repo facility will be depleted vary, with some analysts predicting it could occur between May and July of this year. However, the recent benign conditions in U.S. funding markets suggest that the process may take longer than anticipated. As investors monitor these developments, the delicate balance between excess liquidity, rising interest rates, and potential tightening measures by the Federal Reserve continues to be a key factor influencing market dynamics.


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