Fed Rate Hikes Are Pushing Credit Market Toward Dysfunction, Bank of America Says

(Bloomberg) — The Federal Reserve needs to slow the pace of rate hikes to prevent credit market dysfunction, warned Bank of America Corp. strategists.

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Distress, dispersion and debt-to-enterprise-value ratios were all above June highs, pushing the bank’s measure of credit stress to a “borderline critical zone” this week, strategists Oleg Melentyev and Eric Yu said.

A Fed slowdown and possible pause would “allow the economy to fully adjust to all the extreme tightening already implemented, but still working its way through the financial system’s plumbing,” they wrote in a note dated Friday. Failure to do so risks dysfunction that “would be difficult to contain and fix.”

Leveraged finance markets are reeling this week after the Fed’s latest rate hike in its aggressive campaign to tame inflation. US junk bonds are headed for worst year-to-date losses on record, while banks were forced to shelve a buyout deal in the leveraged loan market after struggling to attract demand from investors.

Investors fled risky assets over fears of a recession, pulling $3 billion from high-yield bonds and $1.9 billion from leveraged loans in the week ended Sept. 28, according to data from Refinitiv Lipper.

Spreads in the high-yield market could rise to around 600 to 650 basis points if the Fed continues with its pace of rate hikes, said BofA. Average high-yield spreads stand at 561 basis points on Friday, according to Bloomberg data.