With fears of oncoming recession still swirling, the corporate bond market continues to mostly mimic a big shoulder-shrug about that very prospect. As we’ve noted, the difference in yield between corporate bonds and comparable risk-free Treasuries (i.e., the credit spread) is one of the go-to places to look for signs of concern, stress, fear, etc. Higher spreads = more fear as the bond market prices in more of a premium for riskier debt, and vice versa. While some of that did start to materialize earlier last year, it’s largely evaporated over the past several months as yields and spreads have come down from their summer peaks.
Currently, the spread to Treasuries for both high-quality (i.e., investment grade, 1st chart) and low-quality (i.e., high yield/junk, 2nd chart) corporates has fallen back below their longer-term averages shown by the horizontal dashed lines even as layoff announcements have picked up, corporate profit margins have come under pressure, and additional Fed rate hikes remain in the pipeline. In other words, even in the face of some mounting headwinds the corporate bond market is acting as if things aren’t all that bad for the economy just yet.
From an investment standpoint, spreads below the averages also reflect a lack of good long-term value and thus we continue to largely avoid the high yield debt market. If the economy does eventually flirt with recession, then spreads will widen and that will present more of an opportunity to begin to allocate to riskier debt. But we’re not there yet.
Things can change quickly and if the Fed does push too far then corporate spreads will eventually react to that. For the time being, they reflect an economy that is holding up better than some of the dire expectations out there. Keep watching this market.
Carl Noble, CFA®
Senior Vice President of Investments
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