Although it belongs to the riskiest part of corporate bonds, as of the end of April, U.S. high-yield bonds (or junk bonds) have seen the Fed tightening monetary policy, rising inflation, continued volatility in U.S. stocks, supply chain disruptions and the Ukraine crisis this year. In the context of bombing, the performance is always good. However, this situation gradually reversed after entering May.
Party City reported disappointing earnings last week after the company struggled in the first quarter under pressure from constrained helium supplies and soaring prices. The price of Party City’s $750 million junk bond due 2026 issued a year ago fell to around 70 cents from 90 cents at the end of April after the earnings report. And as investors begin to reassess whether the junk-bond market can withstand a dimming economic outlook, Party City is not alone.
The ICE U.S. High Yield index was down 8 percent this year through the end of April. The index's decline was thought to be driven almost entirely by a rapid rise in interest rates, though it was still significantly better than the Nasdaq's 30% drop over the same period. This is also consistent with past cycles. When external conditions worsen, bonds typically lose less than stocks because of their higher status in a company's capital structure.
Usually, the spread between junk bonds and U.S. Treasury bonds can reflect investors' confidence in credit risk and the financial health of junk-bond companies. At the beginning of this year, the spread was 3.10%, and as of April 21, it rose to 3.5% and remained stable overall. But since then, the spread has started to climb faster, rising to 3.97% at the end of April. The spread then rose another 0.5 percentage point over the next nine sessions, during which junk bonds were sold more than all of the first four months of the year. This trend of wider spreads is more pronounced for CCC-rated junk bonds, the worst rated among them, and has gradually begun to spread to BBB and BB-rated junk bonds.
In terms of returns, overall CCC-rated bonds outperformed higher-rated bonds earlier this year, as the solid economic outlook led the market to expect the overall health of these companies to improve over time. This narrows interest rate spreads and offsets the negative impact of Fed rate hikes. But in May, returns on CCC-rated bonds fell below the overall return on junk bonds, a clear sign that investor concerns about interest rate risk are starting to turn into concerns about credit risk.
Matt Eagan, portfolio manager at Loomis Sayles, said: “This [junk bond market] has become a very tough market right now, and there’s really no hiding place. And, by the nature of the big sell-off, junk The bond market is also at a turning point (whether a technical sell-off or a longer-term sell-off due to a changing fundamental environment).”
That said, a recent survey of the views of bond fund managers shows that they do not believe a material inflection point in the junk bond market has yet been reached. Confidence among bond fund managers that the junk bond market can withstand further headwinds remains, albeit less dramatically. One of the bond traders even said that “it seems like a buying opportunity right now,” but interestingly, most bond fund managers are still hoping that “other people can start buying first.”
The ICE U.S. High Yield Index is now at 7.5%, and it has only been above that level four times in the past decade, most recently at the height of the coronavirus-induced sell-off. Going back further, it will be traced back to the period of economic growth panic in 2018 and the energy crisis in 2015.
“My benchmark for the bond market at the end of the first quarter was that the U.S. economy would be able to achieve a soft landing,” said Jeremy Burton, an analyst at PineBridge Investments. The odds are indeed on the rise, but I'm sticking with the assumption that the junk bond market will maintain its baseline scenario.
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