"Irrational Exuberance" in the High-Yield Market?

·        Since initially raising interest rates off of the zero-bound in March of 2022, the Federal Reserve has embarked on the most aggressive tightening cycle in more than 40 years, lifting the Fed Funds rate 500 basis points[i]

·        This surge in the cost of money has had a massive impact on corporate financing – through the end of August, 459 companies have filed for bankruptcy this year, which exceeds the full-year totals of both 2021 and 2022[ii]

·        Fitch has noted the impacts of higher interest expenses and tighter lending conditions have already begun to hit high-yield issuers, and the ratings agency is forecasting the default rate to end this year between 4.5-5.0% compared to just 1.3% last year[iii]

·        Despite these distress signs, investors seem to be growing less concerned, as the ICE BofA US High Yield Spread Index has been moving steadily lower since peaking last July[iv]

·        This is also true of the riskiest segment of the high-yield market, with CCC and lower-rated spreads falling roughly 400 basis points since they peaked last October[v]

·        The average maturity of Bloomberg’s US Corporate High Yield Bond Index has fallen to an all-time low of less than 5 years as issuers have delayed refinancing, given the environment of higher interest rates[vi]

·        However, with the Federal Reserve telegraphing “higher for longer,”[vii] issuers may not be able to avoid such costly refinancing before their liabilities come due

·        If these already-distressed issuers are required to increase cash flows to cover higher interest payments, it is our opinion that the default rate in the high-yield segment could exceed market expectations

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[i] www.federalreserve.gov, “Open Market Operations,” July 26, 2023

[ii] www.spglobal.com, “August adds 57 more US corporate bankruptcies; 2023 total tops prior 2 years,” September 12, 2023

[iii] www.fitchratings.com, “U.S. HY Default Rates Grinding Higher as High Rates Challenge Refis,” August 15, 2023

[iv] www.fred.stlouisfed.org, “ICE BofA US High Yield Index Option-Adjusted Spread,” September 22, 2023

[v] www.fred.stlouisfed.org, “ICE BofA CCC and Lower US High Yield Index Option-Adjusted Spread,” September 22, 2023

[vi] www.bloomberg.com, “Bond Buybacks Scrape Record Lows as Age of Easy Money Ends,” September 25, 2023

[vii] www.bloomberg.com, “Fed Signals Higher-for-Longer Rates With Hikes Almost Finished,”