Junk Bond Market Is Signaling the US Will Avoid a Recession

(Bloomberg) — US junk bond markets are forecasting that the economy may weaken, but won’t tip into a recession.

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It comes as Federal Reserve officials vow to continue to fight inflation aggressively, even if higher rates increase the risk of recession. And some strategists and money managers think credit markets aren’t paying enough attention to how bad the potential upcoming downturn could be.

But for now, investors are voting with their dollars. High-yield bonds gained 5.9% in July, their biggest one-month rally in a decade, and have also been rising in August, according to Bloomberg index data.

Risk premiums for the bonds stand at levels not usually associated with recessions. Stocks, junk bonds, and other risk markets rallied in the second half of July as investors grew more hopeful that signs of slowing growth would translate to the Fed easing up on its plans to tighten the money supply.

Those signs of slowing growth are coming from multiple areas. Walmart Inc. last week said shoppers are avoiding big-ticket items and focusing instead on buying groceries. AT&T Inc. said some customers are delaying paying bills. Pending home sales fell in June by the most since April 2020, according to a report last week.

In markets, longer-term Treasury yields are in many cases lower than shorter-term yields, a condition known as inversion that, if persistent, can signal a recession is coming. Commodities prices have broadly been falling this month, too.

Riskier parts of the credit spectrum are also showing some concern. CCC rated bonds, among the lowest-rated corporates, gained 4.95% in July, while BB securities, the top tier of high yield, rose 6.1% on a total return basis.

But it’s not clear if these signs of trouble will translate to a serious downturn.

“The high-yield market is definitely pricing in some level of stress, but it’s pricing in nowhere near recession-type levels,” Citigroup Inc. strategist Michael Anderson said in a phone interview.

Between December 1996 and December 2021, there were 28 months when the economy was in recession, according to an analysis by Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors. The median junk-bond spread during those months was about 835 basis points, or 8.35 percentage points, based on ICE BofA indexes. That spread is currently closer to 460 basis points, around the median level for non-recession months, according to his analysis.

Much of the recent compression in spreads is because of energy debt, which has performed better than the broader high-yield market this year as oil prices have risen, said Scott Kimball, managing director at Loop Capital Asset Management. That may “be skewing expected default rates lower for the broader market, and in turn, giving investors a bit more optimism in buying high-yield broadly.”

Elsewhere in credit markets:

This week’s MLIV Pulse survey focuses on the outlook for credit markets. Please click on the link below if you want to share your views on yields and spreads. The survey is confidential.



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