Chart of the Week: High-Yield Bonds Say Not To Panic

Chart of the Week: High-Yield Bonds Say Not To Panic

Signs of investor panic seem to be everywhere. Whether it’s the Cboe Volatility Index (Wall Street’s “fear gauge”) earning prime placement on newscasts, traders amping up purchases of puts (a bet that the market will fall) or simply reading recent investor surveys, fear is the dominant sentiment. I understand the unease.

One glaring exception to this apparent gloom can be found in the high-yield, or “junk bond,” market. When bond investors fret about the market and the economy, they typically flock to safe assets (e.g., Treasury bonds) and flee risky assets (like junk bonds, which have lower credit ratings due to their higher default risk). The net result is that junk bond yields rise faster than those available on safety-oriented Treasury bonds. The difference in yields is known as the yield spread, or “spread.”

A wide spread between junk bond and Treasury bond yields typically indicates investor fear. Yet, while yields on junk bonds have risen to around 9.5%, their spread over Treasurys has not grown dramatically because Treasury bond yields have also been on the rise. At 5% or so, the spread is bigger than it was at the beginning of the year—a sign that investors are more nervous than they were. But it’s not particularly wide by historical standards. Typically, in times of stress and heightened levels of investor fear, the spread has reached 8% or more.

Note: “High-Yield Spreads” represented by the ICE BofA US High Yield Index Option-Adjusted Spread, which shows the difference in yield between junk bonds and Treasury bonds with similar maturities. “Distressed Level” is a spread of 8% or more. Chart shows monthly spreads from 1/1/97 through 9/28/22. Source: ICE Data Indices, LLC.

So, while the junk bond market suggests investors are on edge, we also conclude that traders are not overly worried about the road ahead. Meanwhile, stock markets and investor sentiment surveys suggest bearishness matches levels seen during the early days of the COVID-19 outbreak as well as the global financial crisis of 2007–2009. Is it stock investors or bond investors who have it right? Only time will tell, but we’ll continue to keep an eye on junk bonds, both for opportunities and as a potential signal for what’s to come.

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