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Investors are warming to the riskiest US corporate debt, as optimism about the state of the world’s biggest economy narrows the gulf between the top and bottom rungs of the $1.35tn junk bond market.
The gap between the yield on double-B and triple-C bonds narrowed to its tightest level in 15 months at 6.53 percentage points in recent days, before widening slightly to 6.74 percentage points at Friday’s close — underscoring investors’ growing confidence that the US can avoid a recession even as the Federal Reserve has raised interest rates 11 times since March last year.
Such hopes of a “soft landing” follow a flurry of positive data, with persistent evidence of easing inflation and better than expected second-quarter growth US growth figures.
The shrinking gap between the top and bottom of the junk debt market — a closely watched barometer of US investors’ risk appetite — marks a turnaround from the aftermath of the failure of two US regional banks in March which compounded fears of a recession and piled pressure on highly-indebted companies’ bonds. The spread between double-B and triple-C bonds widened to 8.52 percentage points in April as investors shunned debt issued by companies most at risk of default in the event of an economic downturn.
“A few months have passed without more bank failures after First Republic”, Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors, referring to the collapse of another lender in May. Many investors are also betting that the Fed has implemented its last interest rate hike, he added. “They’re clinging to that idea, even if [Chair Jay Powell] didn’t give a clear message that they’re done”.
Yields and spreads on junk bonds remain far higher and wider than their lows in 2021, when Fed stimulus was still sloshing around the financial system. Valuations have also been supported this year by a shrinking market, investors say, with upgrades to investment-grade territory and relatively low new issuance anchoring prices at artificial levels.
“We’re still quite a long way from where we were at the beginning of 2022”, added Andzrej Skiba, head of Bluebay US fixed income at RBC GAM, pointing to the period just before the Fed started tightening monetary policy.
Skiba “is not looking to add exposure in triple-Cs in any meaningful fashion”, he said. “[But] I can easily see how managers are increasingly tempted to add exposure to lower-rated issuers. When the music is playing, people get sucked in into buying lower-rated assets.”