On Monday, U.S. junk bond spreads over risk-free Treasuries expanded further, following a significant daily surge at the end of last week, suggesting that financial markets perceive increased risk as stocks decline sharply and investors seek the safety of U.S. government debt. The ICE/BofA U.S. high yield index option adjusted spread jumped by 37 basis points to 372 bp by late Friday. Meanwhile, the ICE/BofA U.S. Investment Grade Corporate Bond Index spread recorded its largest increase since May 2023, closing at 106 bp. Investors have been increasingly flocking to Treasuries as last week's employment reports indicated a slower than expected job growth in July and a rise in the unemployment rate to 4.3% from 4.1% in June. BMO noted in a Monday report that the market sell-off has negated a credit market rally that had persisted for most of the year. However, BMO and other analysts view the widening spreads as a correction rather than a precursor to a recession.
"We're witnessing a significant increase in IG bond market spreads after a year of very stable conditions," commented Blair Shwedo, head of fixed income sales and trading at U.S. Bank. "Nonetheless, this spread increase is not translating into higher overall corporate yields." Concerns over a potential recession have led to calls for an emergency rate cut by the Federal Reserve. However, bond market participants highlighted data on Monday that might alleviate these fears, such as a rebound in the U.S. services sector from a four-year low in July and an increase in the employment rate in that sector for the first time in six months. Some bond investors appear more concerned about the persistent stock market sell-off than the economic data itself.
"Is this an instance where the equity market could impact the economy through a minor wealth destruction?" questioned Jack McIntyre, global fixed income portfolio manager at Brandywine Global, an asset manager. Analysts have varying opinions on how much further corporate bond spreads will widen before reaching their peak. For instance, JPMorgan analysts now anticipate high-yield bond spreads to widen to 500 bp, an increase of 120 bp from their previous forecast of 380 bp. Demand for new corporate bonds decreased on Friday after the sell-off, leading to a rise in concessions offered by issuers entering the market. This could deter some borrowers from accessing the market, potentially reducing August's issuance volume in the short term.
"There are some investors waiting on the sidelines who believe the economy might shift into a recession soon," said Jeremy Burton, high-yield bond and leveraged loan portfolio manager at asset manager PineBridge Investments. "Some of the more marginal issuance is likely to slow down in the near term," he added. Burton and others are optimistic that corporate bond market activity will rebound once spreads stabilize, given the attractive overall yields. "Yes, spreads are wider, but if you're an issuer, this is the best deal in two years," remarked U.S. Bank's Shwedo.
