NEW YORK, May 8 (IFR) - Janet Yellen's first public comments
about market risks this week were largely shrugged off by the
market itself, where the hunt for yield doesn't look to be going
away anytime soon.
The new Fed chairwoman pointed to growing issuance of
leveraged loans and high-yield bonds, as well as a loosening of
underwriting standards, in her testimony to Congress.
But while her focus on specific asset classes raised some
eyebrows, market players are still betting on a prolonged run of
low interest rates and accommodative policies from the Fed.
And that means risk-on mentality - which has fostered the
froth Yellen was supposedly warning about - will continue for
"Mentioning high-yield and leveraged loans in testimony now
sends a subtle signal to the financial community: 'We are
watching, don't get too excited,'" said Oleg Melentyev, head of
US credit strategy at Deutsche Bank.
"They have to send signals one year in advance for the
markets to stay calm," he told IFR.
"The fact that these markets have been mentioned very
specifically by name tells us that when the FOMC makes decisions
about how fast to taper - and to engage in increasing the
Federal Funds Rate - this will be part of their consideration."
Another senior banker said: "The Fed seems to be walking a
tightrope of tamping down froth perceived to be developing in
financial markets whilst continuing to want to stick to its low
interest rate policy."
He added: "That is very unlikely to be a fulfilling
Hot market conditions that Yellen noted have been building
for some time.
While primary high-yield issuance so far this year is at
US$108.8bn, slightly down from US$125.6bn in the same period in
2013, issuance by fringe investment-grade credits - with ratings
on the riskiest band of high-grade bonds - is at US$135.9bn
versus US$120bn a year earlier.
And ominous aspects of the pre-crisis days have again raised
their heads, with a surge of PIK toggle trades, dividend recaps
and Triple C issuance, as well as a rapid tightening of the
mezzanine tranches in structured finance trades.
More broadly, there has been an almost unending stretch of
record low spreads and all-time high primary debt issuance.
But while her predecessor Alan Greenspan's infamous
"irrational exuberance" comment sparked an equity market
sell-off, Yellen's remarks seemed to fall on deaf ears.
Just one day after her comments, the US high-yield market
printed more volume than in all of the previous week.
"There is indeed a search for yield, but that's been
happening for a while," said one senior investment banker.
"And other Fed speakers have mentioned the risks of this
behavior, so I am not sure what these latest remarks are
supposed to indicate. They have never said we should stop doing
NOT THE ONLY WARNING
To be sure, Yellen is not the only observer of late to note
looser structures in the credit markets.
Last month, Covenant Review warned that protections in
covenants are being compromised.
The publication said restricted payments covenants in Rice
Energy's US$750m senior notes due 2022 included a carveout that
could significantly undermine protection if the issuer is
And a similar carveout was included in the recent offering
from Exco Resources.
But several bankers told IFR that, amid the current red-hot
demand in the market, the time from a deal's origination to its
distribution has narrowed so much that banks are not in a
position to make a moral judgment about structural risks.
"If we don't do those deals, someone else will and we would
be missing out on important fee-earning mandates," said one.
"Structures are getting riskier with each day, but there is
sufficient appetite for these trades to get done."
Deutsche Bank's Melentyev meanwhile said that the Fed could
only have limited scope to tighten the reins on leveraged
"If they reacted suddenly to a surge in LBOs, then we would
have a repeat of the rate volatility we saw last May and June,"
"By the time the LBO market comes back, it will be too late
at that point for the Fed to do something about it."
(Reporting by Shankar Ramakrishnan; Additional reporting by
Danielle Robinson; Editing by Marc Carnegie)