Equities aren’t the only thing sizzling this summer.
U.S. corporate bonds with speculative or “junk” credit ratings have also staged a dizzying rally in recent weeks, picking up the momentum seen recently in major stock indexes as investors bet on a soft landing in the US. economy.
Last week, junk bonds posted their fastest decline on record – just 1.2 months – falling from a spread of around 600 basis points to 425 basis points above the Treasury rate without risk from July 5 to August 11, according to Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors. Spreads are an indicator of credit risk.
This is the fastest spread decline ever in this range (see chart), or at least since 1996, when the ICE BofA US High Yield Index was created, according to Fridson.
“Before this year, moves like this had never happened in less than 3.9 months,” Fridson wrote Tuesday, in a comment that first appeared in PitchBook LCD.
“Over a surprisingly short span, high-yield investors came to believe that inflation was sufficiently under control and that the Fed would not have to raise interest rates enough to trigger a deep recession,” Fridson wrote. . “Time will tell if they were right to change their minds on this issue.”
Companies with speculative credit ratings have often been the first to collapse whenever the US economy slows or a recession hits, particularly if it also coincides with scarce or higher borrowing costs.
Investors often get exposure to junk bonds through exchange-traded funds. The two largest are iShares iBoxx $ High Yield Corporate Bond HYG,
and SPDR Bloomberg High Yield Bond ETF JNK,
This year, funds were down 9.7% and 10.5%, respectively, on Tuesday, according to FactSet data.
Historic bond losses in the first half of the year were mostly driven by volatile Treasury yields, with the 10-year TMUBMUSD10Y,
Tuesday nearly 2.8%, against 1.2% a year ago. However, attention has recently turned to potential default risks as weaker companies navigate the Fed’s tightening cycle.
Based on returns, the ICE BofA US High Yield Index tightened to around 7.2% on Monday, after peaking this year’s return of around 8.9% on July 30.
Federal Reserve Chairman Jerome Powell began talking about the potential for a “soft” landing for the U.S. economy in March as the central bank began raising interest rates from lows in the l pandemic era to combat the stubbornly high cost of living.
Recession fears have risen since this spring, with investors worried that consumers will cut back on spending amid soaring inflation and higher borrowing costs as the Fed hikes interest rates.
Lily: Why Vanguard Likes Short-Dated US High Yield Bonds After Recent Big Gains
The S&P 500 SPX,
was up more than 17% through Monday from its mid-June low, but was still down about 10% on the year through Tuesday.