High-risk bonds participate in the rise
The junk-bond market seems oblivious to any potential trouble in the U.S. economy.
Investors are showing less concern about an economic downturn that could lead to increased defaults and bankruptcies, as evidenced by the narrowing spread between sub-investment-grade debt and safer Treasurys. This reduction in the premium demanded by investors is approaching levels last seen during the pandemic.
Low-rated debt has been caught up in a widespread market rally driven by indications of moderating inflation and optimism for potential interest-rate reductions. Investors have been drawn to junk-bond funds this year, with yields around 8%, resulting in a net inflow of $3.7 billion, as reported by Refinitiv Lipper. This marks the first time since 2020 that such inflows have occurred during this period.
Strong demand has fueled bond sales from companies such as Block, led by Jack Dorsey, and Icahn Enterprises, headed by Carl Icahn, in the past few weeks. In the current year, low-rated businesses have collectively issued $131 billion of speculative-grade debt through mid-May, as reported by PitchBook LCD. This represents a significant increase from the approximately $71 billion issued during the same period in 2023.
Investors and analysts closely monitor junk bonds as companies with weaker credit ratings are often the first to feel the impact of economic challenges. There is a notable increase in demand, coupled with a recent upswing in profits among S&P 500 companies. This has raised optimism that the economy will stabilize sufficiently for interest rates to decrease, without the risk of a recession.
“Markets remain optimistic about the possibility of a smooth landing,” commented Matt Brill, who leads Invesco’s North America investment-grade credit division. “The attractive all-in yields are attracting buyers to make investments, and there are minimal worries about a weakening economy.”
After three consecutive months of higher-than-anticipated inflation data, the bond market is experiencing a rebound. This has dampened investors’ expectations for interest-rate cuts. According to data from CME Group, recent indications of slowing price growth have sparked speculation that the Federal Reserve may consider multiple rate cuts this year.
Numerous companies are capitalizing on investors’ desire to refinance their current debt. SS&C Technologies, a provider of software for the financial-services and healthcare industries, has recently issued $750 million of bonds that will mature in 2032. The purpose of this issuance is to repay floating-rate debt that was scheduled to mature as early as April 2025.
Due to the increase in underlying interest rates, the bonds were sold at a yield of 6.5%, which is one percentage point higher than the initial yield on the company’s older bonds issued in 2019. However, the premium, or spread, to Treasurys stood at 1.91 percentage points, which is 1 percentage point lower than the initial spread on the bonds sold in 2019. It appears that investors perceived the new bonds to be less risky than the older bonds at the time of their initial issuance.
SS&C Technologies’ refinancing effort also involved securing a loan of $3.9 billion, which exceeded the initial plan due to the robust demand from investors.
“We identified an opportune moment to pursue refinancing,” stated Brian Schell, the CFO of SS&C Technologies. In the past, the company relied heavily on debt to fund mergers and acquisitions.
At the start of the year, Allied Universal, a company specializing in facility services and security, had approximately $1.9 billion of secured debt that was set to mature in 2026. In February, the company successfully refinanced $1 billion of its debt, effectively extending the maturity to 2031. In more recent times, it once again accessed the bond markets for $500 million following a jobs report that was not as strong as anticipated and a continued narrowing of spreads.
“It was a strategic trade for us,” stated Lasse Glassen, the global chief communications and investor relations officer for Allied Universal. “We capitalized on favorable circumstances.”
There are indications of underlying tension. According to a Moody’s Ratings analysis, the default rate for junk bond issuers has increased to 5.8% over the past 12 months, reaching its highest level in three years. This number encompasses both bankruptcies and debt restructurings that occur outside of the courtroom.
According to Julia Chursin, a senior analyst with Moody’s leveraged-finance and private-credit team, the increase in rates can be attributed to the ongoing financial challenges faced by certain companies owned by private equity firms, which have been struggling to refinance their debt at higher rates.
According to her, the telecommunications and media industries are facing significant challenges such as cord-cutting and the transition to streaming services, making them some of the most vulnerable sectors.
“In the current economic climate, there is a growing desire among individuals to generate additional yield and assume greater credit risk. However, it is important to note that the level of credit risk is increasing,” stated Kevin Loome, a high-yield portfolio manager at T. Rowe Price.
However, there are certain technical factors that may help to maintain lower spreads on high-yield bonds. In recent years, there has been a noticeable increase in businesses reaching investment-grade status or reclaiming it, while the number of businesses falling into the junk category has decreased. According to analysts, this reduction in supply has an impact on the availability for investors.
“The increase in funds pursuing the limited supply of outstanding paper has played a significant role in bolstering market valuations,” commented Michael Anderson, the head of U.S. credit strategy at Citigroup.
