While credit-market bears may get the last word during a recession, it’s still too soon to tell if corporate bond spreads will implode, contends an article in Bloomberg. American corporations started the year in fine shape, bolstered by solid cash reserves built up during the pandemic. And while trailing 12-month high-yield default levels have been creeping up, they’re still quite low, and it may be many more quarters until defaults to become a significant factor.
According to Moody’s Investors Service forecast, default rates will keep rising, but still stay below the historical average from the last 39 years through the 3rd quarter of next year. And Bloomberg data shows that, earlier this year, bankruptcy activity was at the lowest level ever and has only ticked up slightly since. That’s good news for credit spreads, which don’t tend to blow out unless there are major bankruptcies occurring across the economy, the article reports. Given that the U.S. consumer is still buoyant, and unemployment remains low, growth and corporate earnings have a good chance of remaining strong.
But it’s uncertain whether those positives are enough to outweigh the negatives and either make a recession milder, delay it for a few quarters, or if that resilience will force the Fed to keep raising interest rates and tightening monetary policy. As many investors try to find a balance between all the various ways the market could turn, economists still predict even odds that the U.S. will be in a recession some time in the next 12 months, and that prediction has held steady since August, according to a Bloomberg survey cited in the article. While leaving the possibility of a recession up to the fates, market pricing of credit risk actually appears fairly reasonable. Splitting the difference between a recession and a non-recessionary bull market shows a fair value spread of about 563 basis points, and with the spread currently at 548 basis points, the market is already in that territory. Of course, spreads could shift within that range in the short term, especially as real-world facts change.
But all of these factors don’t cancel out the bear market doomsayers; problems may lurk in the private credit markets, which are less transparent, the article maintains. But those doomsayers can probably stop being so down on the high-yield bond market’s laissez-faire attitude toward recession risk. While they may eventually be proven right, it will probably take quite some time.