The additional yield demanded by investors to hold lower-rated corporate bonds versus ultra-secure Treasuries has fallen a striking distance from all-time lows, a sign of investor appetite for riskier assets and the changing composition of bond indices.
On Wednesday, the average additional yield, or spread, on bonds in the Bloomberg Barclays US High Yield Corporate Bond Index was 2.75 percentage points. Earlier this month, the spread fell to 2.62 percentage points, the lowest since June 2007 and just slightly higher than the all-time low of 2.33 percentage points set in May from the same year.
Speculative bond spreads have narrowed by around 0.9 percentage point since the end of last year and 0.3 percentage point since the end of May, suggesting a record high is within reach without major change in investor behavior.
In absolute terms, yields on speculative bonds are already at record levels. This is especially important for companies because it indicates how cheaply they can borrow when issuing new bonds. Investors follow spreads, however, because removing the component of returns determined by benchmark interest rates gives them a better idea of how much they are paid for holding riskier debt.
Investors and analysts say several factors are responsible for the near record spreads. One is optimism about the economic outlook, which still prevails on Wall Street even as concerns have arisen about the Delta variant of Covid-19 and the potential for a tightening of monetary policy by the Federal Reserve. Another is the low yields of the Treasury, which has caused investors to buy riskier assets in search of better returns.
The yield on the benchmark 10-year US Treasury bond stood at 1.297%, according to Tradeweb, up from 1.356% on Wednesday.
Another reason for the low spreads is that speculative-grade bond indices are filled with higher-rated bonds than before, investors and analysts noted.
Currently, 54% of the bonds in the ICE BofA US High Yield Index have an average double B credit rating, the highest rating level below investment grade. This is an increase from 47% two years ago and 38% in 2008, just before the financial crisis.
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The ranks of double-B-rated companies swelled last year when the economic fallout from the coronavirus pandemic sparked a wave of rating downgrades. Companies such as Kraft Heinz Co.
and Ford Motor Co.
lost their investment grade status and fell into speculative grade territory.
Even before that, however, the makeup of high yield indices was changing, as some companies financed debt buyouts exclusively with largely syndicated loans, while many smaller companies sought direct loans from specialist fund managers.
“For a while, high yield has increasingly become the domain of large caps. [companies], which are often higher quality companies or at least higher rated companies, ”said Michael Anderson, head of US credit strategy at Citigroup Inc..
Although the growing number of double-B bonds has reduced the average spread of speculative-grade bonds, the double-B bonds themselves still offer higher spreads than before investors began to register the risks of a pandemic. last year.
On Wednesday, the average spread of double-B bonds in the Bloomberg Barclays Index was 2.03 percentage points, which is still higher than its low of 1.67 percentage points in 2020 set in January of the same year and at the all-time low of 1.3 percentage points set in 1997.
The spread between the yields of double B bonds and those of triple B bonds – the lowest level in the investment grade – is also larger than before the pandemic, which justifies investors to continue buying the bonds more risky.
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