High-Yield Spread Declines... "Is the Recession Risk Overstated?"

Despite concerns about an economic recession, the US high-yield spread is showing a downward trend.

The ICE Bank of America US High Yield Bond Index Option-Adjusted Spread, calculated by Ice Data Indices, the parent company of the New York Stock Exchange, has been declining since reaching a peak of about 6 percentage points in the third quarter of last year through the 31st (local time). As of the end of the first quarter this year, the spread fell below 4 percentage points. It continued to decline even amid the recent months of heightened US default risk due to uncertainties over the federal government's debt ceiling.

The high-yield spread is the difference between the high-yield bond interest rate and the US 10-year Treasury bond yield. A declining spread indicates strengthened investor sentiment in the high-risk corporate bond market.

This trend is contrary to the increased likelihood of a recession due to recent aggressive tightening, the US banking crisis, and the default risk stemming from debt ceiling uncertainties. Typically, the high-yield spread rises ahead of a recession. This phenomenon was observed before previous downturns such as the 2001 IT bubble, the 2008 global financial crisis, and the 2012 European debt crisis.

The market is paying attention to the possibility that recession concerns may be exaggerated. Marty Prisson, Chief Investment Officer (CIO) of Lehman Rivian Freedson Advisors, said, "It is a great mystery that the high-yield spread is decreasing amid rising recession fears," adding, "There is no basis at this point for the market to expect a recession."

[Image source=Reuters Yonhap News]

Additionally, it is analyzed that the possibility of persistent high inflation and high interest rates has stimulated demand for high-yield bonds, which are high-interest bonds. In particular, the reduction in new bond issuance, leading to a shortage in circulating volume, seems to be further stimulating demand for high-yield bonds. According to US market research firm Dealogic, the annual issuance of US high-yield bonds last year was $91 billion, a sharp 77% drop compared to $404 billion in 2021. Also, among the US high-yield bonds issued this year, the proportion of new funding that was not refinancing remained at the lowest level since 1999.

Adam Abbas, co-head of bonds at Harris Associates, said, "The limited new issuance means there is not much circulating volume itself, which is supporting high-yield bond prices."

Meanwhile, the current yield on US high-yield bonds is around 9%, similar to the level in March when fears of a banking crisis triggered by the collapse of Silicon Valley Bank (SVB) peaked.