How will the US corporate bond market handle Fed tightening?

It is tempting to think that the onset of tighter Fed policy will heap more misery on the US corporate bond market. But economists doubt that this will be the case, given the economic context in which it should be undertaken.

The spreads of US corporate bonds over Treasuries have been creeping higher since last summer. At first, this was due to a collapse in oil prices, which hit debt-laden borrowers in the energy sector hard. Since this summer, though, the increase in spreads has become broader-based - while the spreads of borrowers in the energy sector have headed even higher as the price of oil has fallen further (the price tumbled again on Monday after OPEC's failure on Friday to announce an explicit target for production), the spreads of borrowers outside the energy sector have also climbed significantly.

Admittedly, this has partly reflected the persistent weakness in the prices of other commodities, which has weighed on borrowers in the steel, as well as metals and mining, sectors. But there has also been a general rise in spreads outside commodity sectors. At least some of this rise is likely to have reflected concerns about the implications of more restrictive US monetary policy.

Despite an increase in the indebtedness of Corporate America, these concerns should not be exaggerated. Many companies will have locked in low borrowing costs in recent years, while in any case, net interest expenditure does not typically account for a large share of companies' overall outlays.

 The historical evidence also suggests that such concerns will not build once the Fed begins to tighten policy. Shows average changes in the yields of 7-10 year US bonds (and corresponding spreads) in the six months before and after the first rate hike in the last three major tightening cycles. (These began in 1994, 1999 and 2004.)  On average, BBB- and BB-rated corporate bonds fared better than Treasuries, beforehand and afterwards.

"We don't see why things should be different this time around, given that the Fed is contemplating tightening monetary policy in order to constrain the growth of demand in a healthy economy. So just because corporate bonds have fared worse than Treasuries over the last six months does not mean that they will perform worse over the next six", says Capital Economics.