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The Fed Sends the Capital Markets a Reminder

Federal Reserve chairman Janet Yellen has said that a Federal Funds rate hike could come as early as six months after the end of the Fed’s monthly bond-purchasing policy. Her comments, which roiled the markets, offered a sharp reminder that the current low-interest rates environment will eventually end.

Senior bankers at J.P. Morgan believe that investor appetites for equities and debt —both investment-grade and high-yield credits — remain robust. They also point out that risks, such as a significant (100 bps) shift in the Treasury market or disappointing macroeconomic data coming out of Europe or China, could upset current market conditions.

Given the current liquidity and strength in the credit and equity markets, it is critical that in managing capital and navigating markets, treasurers keep in mind that the Federal Reserve will eventually begin raising the Federal Funds rate and that the costs of borrowing will rise. 

HIGHLIGHTS

Treasury Market: While the Federal Open Market Committee target for the Fed Funds rate still ranges from zero to 0.25%, the Treasury yield curve has flattened in anticipation of a tightening monetary policy. Yields on short-term Treasury bills rose in late March, while those on long-term bonds remained relatively stable. The upward pressure on market rates is likely to continue unless there is a dramatic change in economic conditions, which is considered unlikely at this point.

J.P. Morgan expects 10-year Treasury bills to rise to 3.4% by the end of 2014, and the Fed Funds rate to reach 2.75% by the end of 2016.

Equity Market: The drop in equity prices in the aftermath of Yellen’s comments presented a buying opportunity for most corporates. Some of the market’s underpinnings include money inflows into equities, which turned positive in 2013 and have continued to remain positive in 2014 year to date; foreign investment in the equity market; and the return of retail investor to the stock market. 

J.P. Morgan projects that the S&P 500 index could reach 2075 by the end of 2014.

Investment-Grade Bonds: Investment-grade bond issuance hit an all-time high in 2013 as firms took advantage of ultra-low rates and strong demand. Credit spreads, demand and liquidity continue to favor continued activity.

J.P. Morgan expects high-grade corporate credits to continue to benefit from strong demand and relatively tight supply in 2014.

High-Yield Bonds: Global high-yield bond issuance reached a record in 2013 with strong investor demand. Roughly 45% of the high-yield bonds issued last year had coupons in the 4% to 5% range.

J.P. Morgan forecasts demand to remain strong as fixed income investors move into high-yield issues for returns.

Convertible Bonds: Thanks in part to the strength of the equity market last year, 145 companies issued convertible bond offerings in 2013. Companies have been tapping the convertible bond market to fund merger-and-acquisition activity.

J.P. Morgan expects that the convertible bond market will continue to benefit in 2014 from the ongoing demand for yield, coupled with the strong equity market.


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