The U.S. high-yield corporate credit spread is widening, which typically precedes downturns in risk assets such as equities. While our technical studies have not signaled an immediate shift to cash, we are starting to position more defensively across portfolios.
High-yield “junk bonds” are deemed the most risky part of the credit market. Therefore, signs of credit stress suggest investors are demanding a greater risk premium to compensate for low returns and the possibility of default. Currently, credit conditions appear to be healthy, which lowers the probability of an extreme market correction or recession.
Wider spreads could be driven by technical factors similar to late 2018 when declining Treasury bond yields and prospects for tighter monetary policy resulted in lower risk appetite. Stress in the energy market was also a reason for wider credit spreads in 2018. For now, it appears that the pandemic recovery is slowing as the Federal Reserve prepares to scale back asset purchases sooner than expected.
High-Yield Spread vs. S&P 500