(Bloomberg) — Investors are pouring money into corporate bonds, risk premiums are grinding tighter, and the Federal Reserve’s rate of interest cut is reigniting hopes the US will dodge a recession.

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Some money managers say the market is solely too complacent about causes for concern now.

“You should have the US election coming up, and expectations around economic growth in Germany are among the many weakest it’s been since pre-Covid times,” said Simon Matthews, a senior portfolio manager at Neuberger Berman. “Consumers are feeling the pinch and growth in China is slowing. When you pull that all together, it’s not telling you that credit spreads should be near the tights,” he added, noting that falling borrowing costs will help reduce among the many headwinds.

Investors have been setting aside the potential negatives and diving deeper into the riskiest corners of credit throughout the hunt for higher yields. The underside-rated bonds are literally outperforming the broader junk bond market while demand for Additional Tier 1 bonds, which can force losses on investors to help a bank survive turmoil, is anticipated to increase.

Buyers are betting that lower borrowing costs will enable debt-laden corporations to refinance and push out their maturities, limiting defaults and supporting valuations. And as short-term rates drop, investors are expected to shift their allocations into medium- and longer-term corporate debt from money markets which could cause spreads to tighten even further.

Still, inflation could start ticking up again if consumers start spending more as rates of interest are cut, in step with Hunter Hayes, chief investment officer at Intrepid Capital Management Inc.

“Who knows, perhaps the Fed funds rate has to come back back right back up prefer it has in previous inflationary cycles after which, impulsively, high-yield bonds are lots less attractive again,” he said.

With US monetary policy more prone to remain restrictive, market participants are also looking forward to signs of decay in fundamentals, especially amongst borrowers exposed to floating-rate debt, BlackRock Inc. researchers Amanda Lynam and Dominique Bly wrote in a note. In addition to, issuers rated CCC remain pressured in aggregate, despite the recent outperformance of their debt, they wrote.

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They cited low levels of earnings the companies have in aggregate compared with their interest expense. Borrowing costs for CCC rated firms are still around 10% — crippling for some small corporations once they should refinance following the highest of the easy money era — and leaving them at risk of default similtaneously rates fall.

Any weakness throughout the labor market would also “be a headwind for spreads because it’ll increase recession fears and lower yields,” JPMorgan Chase & Co. analysts including Eric Beinstein and Nathaniel Rosenbaum wrote in a research note this past week.

To ensure, valuation concerns remain modest and investors are for probably probably the most part chubby corporate debt. The beginning of the rate-cutting cycle also must support demand for non-cyclicals over cyclicals throughout the investment-grade market, analysts at BNP Paribas SA wrote in a note.

Specifically, limited issuance by health care firms and utilities provide room for spread compression, they added.

“It’s a primary opportunity for non-cyclicals to outperform,” Meghan Robson, the bank’s head of US credit strategy, said in an interview. “Cyclicals we expect are overvalued.”

Week in Review

• Traders are piling into bets on further easing by the US central bank after it cut rates of interest on Wednesday by a half percentage point — its first reduction in 4 years. The historic move ended weeks of speculation about whether the Federal Reserve would kickstart its easing cycle with a quarter- or half-point cut.

  • The cut is supportive of credit spreads overall, but it surely’ll encourage corporate bond issuance — particularly from high-yield issuers. The cut will likely favor those borrowing on the front- quite than back-end of the yield curve, in step with market participants surveyed by Bloomberg

  • Credit derivative spreads dipped Wednesday following the move, to around their narrowest since the pandemic

  • Nonetheless, Fed Governor Michelle Bowman warns that the 50 basis point reduction “may be interpreted as a premature declaration of victory” over inflation

  • In other central bank news, the Bank of England kept rates unchanged and warned investors it won’t rush to ease monetary policy

• Wall Street banks burned two years ago after backing big corporate buyouts and ending up with tens of billions of dollars of “hung debt” are literally back for more, on the point of underwrite more European LBOs.

• Firms benefiting from lower financing costs to win higher terms on existing debt or to push out maturities have borrowed probably probably the most from the US leveraged loan market in seven years.

• Liquidators of China Evergrande Group, the world’s most indebted builder, are returning to a Hong Kong court as they struggle and wind up a subsidiary with key assets.

• UBS Group AG is leading a $1.15 billion financing package to support Vista Equity Partners’ acquisition of software company Jaggaer, beating out direct lenders who were also competing for the deal.

• Apollo Global Management Inc. clinched $5 billion in fresh firepower from BNP Paribas SA since it looks to grow a key lending business, muscling deeper into turf once dominated by banks.

• A much larger share of managers throughout the $1 trillion US collateralized loan obligation market are able to purchase and sell loans more freely than once feared, after a refinancing and resetting surge pushed back the clock on reinvesting limits.

• On this planet of non-public credit, KKR & Co.’s capital markets arm led a financing for USIC Holdings to help repay broadly syndicated debt, while Oak Hill Advisors provided $775 million to support Carlyle Group Inc.’s purchase of Worldpac, and Alegeus Technologies is searching for to rating about $75 million in interest savings through refinancing the private loan that Vista Equity Partners used to take the company private in 2018.

• Tupperware filed for bankruptcy after a years-long struggle with sales declines and growing competition.

• Bankrupt trucker Yellow Corp. and its hedge fund owners lost a key court ruling over $6.5 billion in debt that pension funds claim the defunct company owes them, likely wiping out most recovery for shareholders.

• Bausch Health Cos. is working with Jefferies Financial Group to explore refinancing just a few of its debt to help a long-planned spinoff of its stake throughout the eye-care company Bausch + Lomb.

On the Move

• BlackRock Inc. is overhauling its private credit business. The firm is organising a recent division, Global Direct Lending, appointing Stephan Caron, head of the European middle-market private debt business, to guide it. Jim Keenan, global head of BlackRock’s private debt business, will leave the firm next 12 months, as will Raj Vig, co-head of US private capital.

• Silver Point Capital has hired Joseph McElwee from Investcorp as head of collateralized loan obligation capital markets and structuring.

• Jefferies Financial Group Inc. has hired former Citigroup Inc. banker Simon Francis in a newly created role leading its debt financing business in Europe, the Middle East and Africa.

• Fidelity Investments has recruited Lendell Thompson, a former director at Vista Credit Partners, since it continues expanding into the private credit market. He’ll likely be a managing director throughout the firm’s direct lending team.

–With assistance from Dan Wilchins and James Crombie.

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