Risk premiums have been shrinking for most of the year, even if they edged higher in the latest week. The extra yield that investors demand for buying junk bonds instead of high-grade debt has been shrinking, signaling less fear of default. A key measure of that gap was just 1.02 percentage point on Thursday, according to data compiled by Bloomberg, close to the lowest in about two years. 

Investors have found a series of reasons to buy corporate debt. Mixed economic data implies that the Federal Reserve won’t have reason to hike further, even if hopes of rate cuts are fading. Insurance companies that have sold annuities and pension plans that are funding retirees are eager to lock in high yields and buy company bonds. 

“What we are seeing is a general move toward a growing comfort with risk,” said Richard Cheng, an investment-grade portfolio manager at Nuveen. “Expectations of a soft landing continue to grow and macro forecasts continue to remain optimistic,” he said in a phone interview on Friday.

US consumer sentiment posted a surprise drop in late February as the outlook for the economy deteriorated. But in the latest week, the Fed’s preferred inflation gauge posted its fastest acceleration in a year, implying a recession isn’t near.

There are risks ahead. Investment-grade bonds have relatively long duration, making them sensitive to rates if the Fed, for example, is much slower to cut rates than investors hope for. And money managers are showing early signs of getting full on high-grade bond sales. Companies are having to offer higher yields relative to existing securities to convince fund managers to buy.    

Still, for now, investors are deluging credit funds with money. Weekly inflows for US investment-grade debt in February, for example, have averaged $6.4 billion, up 10% versus $5.8 billion seen in January, JPMorgan Chase & Co. strategists led by Eric Beinstein wrote in a note Friday. Money has flowed into US junk bond funds seven out of nine weeks so far this year, according to LSEG Lipper data. 

Bank of America Corp. forecasts a record $500 billion of flows into high-grade corporate debt this year, with one strategist at the firm describing conditions as “bubbly.” Strategists at Barclays Plc say as much as $600 billion could shift out of money-market funds into riskier assets, with credit likely to be favored over stocks.

Insatiable investor demand has helped lift January and February high-grade corporate bond sales in the US to record levels, topping $387 billion as of Friday. The first quarter may end up being the busiest on record if issuance in March stays even moderately strong.  

Amid that demand, the average spread for US investment-grade bonds traded at 96 basis points on Thursday. While risk premiums have widened over the past week, they have narrowed 0.03 percentage point since the start of the year. The average junk-bond spread was 3.12 percentage points, about 0.2 percentage point tighter than the end of last year. 

Barclays has an index of fear in credit markets that it calls its Complacency Signal. That gauge remains elevated at 80%, the highest level since January 2022, strategist Andrew Johnson wrote in a note on Friday. The measure reflects a decrease in realized volatility of high-yield returns and a decrease in the distressed rate, which were partly offset by slight weakness in high-yield spreads. 

“Fixed income still looks compelling,” said Sonali Pier, a high-yield and multi-sector credit portfolio manager at Pacific Investment Management Co. “Even if we were to see some GDP contraction, it’s still a benign enough macro environment for credit to continue to perform.” 

Click here to listen to a podcast about the opportunities that could arise as banks shed loans. 

Week in Review

On the Move

–With assistance from Andrew Kostic and Taryana Odayar.

More stories like this are available on bloomberg.com

©2024 Bloomberg L.P.

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Published: 03 Mar 2024, 02:04 AM IST