Bond Prices Rebound After A Disastrous 2022

The market has seen a rise in debt offerings from both stronger and weaker companies alike this year.

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An encouraging sign for investors who suffered double-digit losses last year, corporate bonds have surged out of the gate in 2023.

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Prices for company bonds have risen in recent months, while their yields have decreased, particularly concerning those on low-risk government notes, which have also risen recently. This is a reflection of the traders' improved conviction that businesses will be able to withstand any economic downturn that may come their way with the least amount of stress. Despite last year's miserable performance for the fixed-income markets, these gains have erased a substantial portion of last year's losses, which shattered many long-held Wall Street strategies that were supposed to ensure the stability of investors' portfolios.

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Since the beginning of the year, the Intercontinental Exchange (ICE)'s index of investment-grade corporate bonds has returned a total of 3.4%, accounting for both price changes and interest payments. There has been an increase of 4.4% in junk-rated bonds, which are below investment grade.

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It represents a reversal from last year's experience when bond yields rose at every turn. Bond yields rose as bond prices fell throughout the year.

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A dual threat to prices in 2022 was rising interest rates, which kept lower-yielding bonds from appreciating, and fears of a recession, which scared off some investors from lending to businesses that might struggle to repay debts if a recession were to strike. As a whole, ICE's high-yield and investment-grade indexes lost 11% and 15%, respectively, during the past year.

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The investors have recently bet, however, that both of those challenges are receding soon. It can be said that traders grew more convinced of the end of the Fed's series of rate hikes following the Federal Reserve's meeting last week, as their bets on futures markets showed. Contrary to the Federal Reserve's forecasts, they have even projected that the central bank will switch to cutting rates before the end of the year, contrary to its forecasts.

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The strong employment report released by the Labor Department on Friday jostled investors' expectations and forced them to question whether the Federal Reserve may still need to raise rates further to cool the economy further. Michael Chang, a portfolio manager at Vanguard, said that the surprisingly strong data served as a reminder that the economic outlook remains highly uncertain. In the subsequent trading session, bond prices declined.

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The falling unemployment rate added, however, to the evidence that a deep downturn seems very far off in the future. As of this month, the extra yield or spread that investors are looking for when investing in junk bonds as opposed to U.S. Government Bonds has fallen to less than 4 percentage points, a level well below the levels that would indicate serious concerns about defaults in the future. After the Covid-19 pandemic occurred in the early stages of the financial crisis of 2008, junk bond spreads topped 10% and rose to over 20% during the time of the recession.

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A stronger corporate balance sheet, as shown by the higher credit ratings for the companies, indicates that the risks associated with this economic cycle are lower than during previous downturns, according to Chang. However, he pointed out that it is too early for the all-clear to be sounded just yet.

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“At the moment, the spreads are at such a low level that there is not much room for positive surprises to be absorbed,” Chang explained. Rather than focusing on sectors like the housing market in which demand is receding as the pandemic fades and interest rates rise, he favors high-yield bonds from industries like airlines and cruise lines where recovery is still occurring as a result of the pandemic.

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A lack of debt maturities coming up in the next few months is helping to smooth the outlook for bonds this year. During the pandemic, investment-grade and junk-rated companies alike took advantage of cheap borrowing costs, resetting their debt repayment schedules.

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A total of $106 billion is expected to mature in high-yield bonds this year and next, compared with $881 billion expected to mature between 2026 and 2029, according to Trade Algo. The results of this study suggest a near-term recession would not coincide with large funding needs for risky borrowers at the same time, which would mute the risk of a credit crunch soon.

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Several warning signs in the government bond market, a slowing housing market, falling consumer spending, and layoffs at some big tech companies prompted fears of a recession last year. Despite this, Goldman Sachs researchers found that credit risks for even junk-rated companies may be more benign under the surface than they appear. 

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In their analysis of borrowers' financial statements, the team concluded that the default rate for junk-rated companies might reach 2.8% in 2014, a rise from recent months, but still well below the levels reached during previous recessions.

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Even though interest rates have remained relatively high, the falling yields have somewhat reduced companies' borrowing costs this year, enticing a few corporate finance chiefs to raise funds through the sale of new bonds even though interest rates are still relatively high. It has been found that junk-rated companies typically sell new debt at yields of 8.5% in January, down from more than 12% in the fall, according to Trade Algo.

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LCD's data shows that low-rated companies issued $20.6 billion worth of bonds last month, contributing to thawing the frozen fundraising market in 2022, LCD's data shows. Due to the Fed's rapid increases in interest rates last year, borrowers stayed away from the market, and from May through December, issuance was capped below $10 billion every month.

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As of February, borrowing has jumped out to a solid start. This is resulting from a $2 billion investment-grade bond sale from Northrop Grumman Corp. ACI -0.35% decrease; red down-pointing triangle Cos. and a $750 million junk-rated offering from Albertsons Inc. ACI -0.35% decrease; green up pointing triangle Cos. together have accounted for more than $15 billion in new issuance across the two markets on Monday alone.

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Sean Feeley, a fixed-income portfolio manager at Barings, says lower bond prices and higher yields can result from healthy volumes of low-rated debt issuance. In his opinion, junk bonds may not adequately compensate investors for the risk that corporate earnings could falter later this year with spreads below 4 percentage points.

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Feeley said this year's risk bid has been relentless. "We've been pleading for more new issuance to absorb this excess demand."