As Risks Balloon, Yield Chasers Blow Off The Fed

"This emerging trend highlights just how much risk some investors are willing to take in the current environment."
The Fed's explicit purpose of "removing accommodation" - hiking interest rates and unwinding QE - is to tighten the ultra-loose "financial conditions" that have prevailed for the past nine years. By tightening "financial conditions," the Fed is trying to bring markets "gradually" - rather than all at once - back to earth: higher yields, wider spreads, higher risk premiums, etc. By definition, this entails lower asset prices for investors and more expensive and harder to get credit for borrowers, particularly at the riskier part of the spectrum. But for now, the strategy is not working.
The longer the Fed's strategy is not working, the longer the Fed will raise rates, and the higher the risks will be that, instead of working "gradually," as the Fed always says, its strategy is going to work belatedly but all of a sudden - which would make for a brutal surprise.
Just how widespread is this? Take asset-backed securities (ABS) backed by subprime auto loans. Subprime auto-loan defaults in March hit the highest level since 2008 though they've backed off some. These structured securities have tranches with different credit ratings. At the time they're issued, the tranches may range from AAA to deep-junk B. The lowest-rated tranches would take the first loss, and rising default rates make... Read more