2024-11-29 09:30:31 :
Credit investors often speak in tactful tones. The safest bonds have the highest credit ratings and therefore the lowest yields and are almost always called “high grade” rather than “low yield.” Conversely, something that is riskier and more likely to default is politely called “high yield” rather than “low grade.” Lately, though, yields on so-called high-yield bonds haven’t been that high.
In fact, on November 24, for the first time, the spread (or additional yield) enjoyed by investors in U.S. high-yield bonds and the spread enjoyed by investors in Treasuries was lower than the spread on fixed-rate residential mortgages. Since high-yield bonds have higher default rates over the long term, these moves have investors wondering what’s going on.
Part of the reason is that residential mortgage spreads have widened. As the Federal Reserve cuts interest rates, investors have begun to consider the risks for mortgage holders to refinance their debt. The more notable action, however, was in high-yield credit spreads. The spread between high-yield bonds and U.S. Treasuries fell from 3.7 percentage points at the beginning of the year to 3.2 percentage points this summer. Since September, the index has fallen to just 2.6 points. It is now close to the historic lows reached before the global financial crisis of 2007-09 (see Figure 1).
The comparison isn’t entirely apples-to-apples. Since the financial crisis, private credit has boomed (see Figure 2), with funds lent directly to businesses rather than through publicly traded bonds. The industry tends to take on the most desperate borrowers, meaning such companies are no longer pushing yields higher.
Yet the shift does reflect rapidly changing sentiments. It’s another part of Trump’s deal that has captivated markets over the past month, sending U.S. stocks and the dollar soaring. The president-elect’s proposed corporate tax cuts would be particularly popular with indebted businesses, freeing up cash to pay interest. Rapid economic growth driven by deficits will also be a boon to these companies.
Credit strategists describe the mood among junk bond investors as bordering on ecstatic. A Bank of America survey of asset managers conducted before the election found that 1% net balances expected high-grade debt to outperform high-yield debt in the coming months. After the election, a net 41% expected high-yield bonds to perform better.
Lower interest rates have also prompted a search for yield among investors, who are now considering riskier bets. Fund managers pointed out that the yield on U.S. investment-grade corporate bonds was 6% a year ago and is now 5.3%. By comparison, lower-rated debt still offers interest rates of around 6.9%. U.S. and European high-yield funds have seen huge inflows this year, pushing down spreads. When they decline, they also improve credit quality by reducing the company’s risk of surprises when it refinances existing debt.
However, not all investors are in the party mood. Short positions in corporate credit – bets on falling prices – have grown 25% in the past year to $336 billion, according to data compiled by S&P Global Market Intelligence. Meanwhile, companies are scrambling to take advantage of a surge in debt issuance as borrowers seek to lock in attractive interest rates. Analysts expect $15 billion to $20 billion in new stock issuance in the week before Thanksgiving, three to four times the usual amount. How many will prove to be turkeys?
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