Investors are shying away from the riskiest US corporate debt as fears of an impending recession fuel a growing divide between the highest- and lowest-rated companies in the $1.4tn high-yield bond market.
Last month’s banking crisis sparked a sell-off in so-called junk bonds of all stripes. But while higher-quality debt has clawed back its losses, investors have been reluctant to re-enter more speculative bets as they worry that an economic downturn could lead to defaults among the most indebted companies.
“Investors do see some type of recession coming,” said Steve Caprio, head of European and US credit strategy at Deutsche Bank. “If there is going to be some US growth and earnings slowdown, they would rather be in the higher-quality securities today.
” Average yields on double-B rated US bonds — the top rung of the non-investment-grade ladder, comprising half the overall junk bond market — have fallen to 6.8 per cent from a peak of 7.5 per cent in mid-March, trading close to levels seen in early February.
By contrast, borrowers with weaker ratings have remained under pressure. An index of triple-C and lower bonds tracked by Ice Data Services currently yields 15.3 per cent — down slightly from a high of 15.6 per cent on March 20, but still well above levels from two months ago.
The growing gulf in the high-yield market comes after the failure of Silicon Valley Bank on March 10 and a subsequent rescue deal for Credit Suisse sent shockwaves through financial markets and fuelled investor concerns over the health of the global economy. Investors are also demanding a lower premium to buy double-B rated debt than they were in mid-March. The spread, or gap between those bond yields and ultra-safe US bonds, now averages 2.9 percentage points, down from 3.66 percentage points. The triple-C spread is much wider at 11.41 percentage points — narrowing slightly from a gulf of 11.86 percentage points on March 24, but remaining above levels seen on March 9, the day before SVB collapsed.
Spreads are viewed as an indicator of how likely a company is to default on its obligations to lenders, with investors demanding a higher interest rate when that risk increases.
Worries about an economic contraction have contributed to rising expectations of default. A member survey published on Thursday by the International Association of Credit Portfolio Managers found that 84 per cent of respondents believe a recession will hit the US “sometime this year”. Eighty-six per cent said defaults will rise in North America over the next 12 months.
IACPM members, which include banks and investment managers, said that “ongoing challenges posed by rising inflation, higher interest rates and geopolitical concerns are now joined by a threat to credit availability caused by reduced bank liquidity and credit risk concerns.”
“This is an environment where you will see continued bifurcation between large, high-quality firms that have diversified business mixes, that have better operational agility, more financing options, and those who are smaller and lack any of those options,” said Lotfi Karoui, chief credit strategist at Goldman Sachs.
A dearth of junk bond issuance since SVB and fellow bank Signature failed has also helped to stabilise prices. The minimal new supply has been in stark contrast to the first two months of the year, when risky debt rallied on evidence of cooling inflation.
That static market “has continued to provide a firm technical support” for participants, said Kelly Burton, high-yield portfolio manager at Barings.
Burton said she would be “pretty selective” about buying any lower-rated debt. “We’re content to be patient, sit on cash and wait for a better day, or a better issuer frankly that’s higher quality in nature — a company that either has a better capital structure in general with lower leverage or better sustainable cash flows.”
