With the Federal Reserve intent on gradually normalizing interest rates and default risks rising, fixed-income investors may utilize inverse or short bond exchange traded funds to hedge their corporate debt exposure.
Banks and investors are turning to alternative tools to hedge losses as credit markets grow more vulnerable to shocks from commodity prices, notably depressed oil prices, and rising rates, reports Alastair Marsh for Bloomberg.
Corporate defaults have increased to 107 gobally this year, with almost 40% of those associated with oil and gas or metal and mining sectors – these highly indebted companies have been under pressure after the sudden fallout in crude oil prices due to rising output and dip in industrial metals prices as the global economy slowed. Ratings agency Standard & Poor’s also warned that the pressure in these sectors are beginning to affect other speculative-grade debt issuers.
The S&P anticipates that trailing default rates in the U.S. will increase to 3.3% by September from 2.5% a year earlier.
While credit-default swaps remain a popular hedging play, traders have been less apt to utilize the financial tools ever since regulators imposed new rules in response to the financial crisis.
“Anything from a worsening of the commodities rout to a central bank policy mistake could be the trigger for pain,” Regina Borromeo, a money manager at Brandywine Global Investment Management, told Bloomberg. “They’ll need hedging tools to ride out the storm.”
Alternatively, more investors are using short sales of ETFs in anticipation of price declines.