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Stocks and cryptocurrency markets have gotten shellacked lately as anticipation of Federal Reserve policy tightening this year prompts concern—and deleveraging—from traders. But high-yield bonds, a key market that is seen as a bellwether for risk assets, have held up fairly well over the past week.
Before the late-afternoon rebound, the picture painted by stock markets was grim, and the action in cryptocurrency was grimmer: the
Nasdaq Composite
and
S&P 500
were in correction territory on Monday afternoon. Bitcoin’s price briefly dropped below $35,000, roughly half its high of nearly $69,000 from November. It had dropped nearly 20% in just 7 days.
Other corners of markets have consistently backed up the idea that the declines may just be a “panic attack.” High-yield bonds, in particular, were moderately lower during Monday’s session, and their decline was muted in comparison to the stock-market selloff. The
iShares iBoxx $ High Yield Corporate Bond
exchange-traded fund (ticker: HYG) was down 0.4% Monday afternoon. It dropped as much as 0.8% earlier in the session, matching a decline from Jan. 5.
The declines in stocks and jump in volatility “are all signs of a healthy market reaction” to the threat of Fed tightening, while “credit remains surprisingly immune so far,” wrote strategists at
Bank of America in a Jan. 21 note.
Stress in markets for lower-rated credit is seen as a reliable signal for economic and financial problems. Because those markets are less liquid, they tend to be insulated from the quick shifts in sentiment that can strike stocks and cryptocurrencies.
That’s not to say high-yield bonds are a great bet right now—fixed-rate bonds usually post losses when the Fed tightens monetary policy, and last week the iShares high-yield bond ETF saw its biggest single-day outflow since early 2020. And broadly, the corporate bond market’s reliability as an indicator could be skewed after the Fed stepped in to buy corporate debt during the early days of the Covid-19 pandemic.
Still, the central bank only bought bonds of companies that had an investment-grade rating at the start of the pandemic, so high-yield bonds may still be a good bellwether.
Trends within the bond market should allay fears of an economic meltdown as well. Junk-rated bonds have been outperforming higher-rated debt so far this year, losing 1.5% for the year through Jan. 21, compared with a loss of 2.3% for investment-grade bonds, according to ICE Indices. And the yield gap between junk bonds and Treasuries, a rough way to gauge market default risk, has remained small at around 3.3 percentage points, only slightly higher than the post-financial-crisis low of 3 percentage points reached last year.
That yield gap widened and risky bonds on Monday, going by one credit-market derivative index, but the selloff didn’t rival the carnage experienced during the 2020 market turmoil.
In afternoon trading, the iShares high-yield ETF was down 0.4%, compared with a 0.2% decline from the
iShares iBoxx $ Investment Grade Corporate Bond
ETF (LQD). That is a shift from their year-to-date performance, where the high-yield ETF’s 2.2% drop has bested the investment-grade’s ETF’s 2.8% decline.
For now, at least, the junk-bond market shows that investors aren’t yet worried about the Fed raising rates so quickly that risky companies default on floating-rate debt or struggle to refinance fixed-rate bonds.
And Monday’s relatively strong performance from investment-grade bonds highlights another reason the market will likely take periodic breathers even if tech valuations are on an extended path lower: Investors’ panic about the Fed’s rate increases will likely cause them to buy Treasuries, pushing yields lower and reducing financing costs for anyone borrowing in dollars—in short, offsetting the Fed’s rate increases. The 10-year Treasury yield rose to 1.8% on Monday as stocks rebounded sharply, after earlier trading lower.
In other words, absent an economic shock or a Fed mistake, the bond market could act as a brake on the stock markets’ declines.
Write to Alexandra Scaggs at [email protected]
https://www.barrons.com/articles/as-stocks-zigzag-high-yield-bonds-show-no-panic-that-reflects-a-healthy-market-51643059674
