THE BOTTOM LINE
- Economic conditions in the U.S. are strongly positive – that’s the signal being sent by the market for high-yield corporate bonds now, continuing the past year’s trend.
- Investors and economists remain reassured by low high-yield spreads, which reached a five-year low of 3.03% on October 3, 2018.
- In fact, this particular credit spread has been below its median level of 3.97% since early 2017 and has stayed roughly one standard-deviation below its five-year average for all of 2018.
- All this suggests a sunnier near-term outlook for those who have been reading the flattening U.S. Treasury yield curve, and its possible inversion at some point in the future, as an early signal that recession could be in the cards a year and a half from now.
- That’s because below-investment-grade (that is, high-yield) bonds are typically backed by relatively risky assets and/or income of a business that might not do well in uncertain financial conditions. Examples include short-term accounts receivable from customers, since poor economic conditions can affect those customers’ ability to pay their bills.
- When business conditions are strong, that makes those risks more palatable, and buyers respond by raising the price high-yield bonds can command, pushing down yield spreads, which measure rates relative to the overall interest rate environment.
- Of course, continued strength near-term does not rule out a downturn next year or in early 2020.
- But for now, this particular indicator for high-yield corporates is showing few signs of strain.
Unless otherwise noted, all data Source: Bloomberg, as of October 19, 2018
The Bloomberg Barclays US Corporate High Yield Average Option-Adjusted Spread measures the option-adjusted credit spread of the Bloomberg Barclays U.S. Corporate High Yield Index, which measures the US dollar-denominated, high yield, fixed-rate corporate bond market.
An Option-Adjusted Spread (OAS) is a measure of risk that shows credit spreads with adjustments made to neutralize the impact of embedded options. A credit spread is the difference in yield between two similar types of fixed income securities but with different credit ratings. .