One of the ways that we track investor expectations for economic growth is by looking at the high yield or below investment grade market. Issuers in that part of the credit market have fewer funding options than investment grade issuers and are sensitive to changes in investors willingness to provide new capital at affordable rates. As investor expectations for economic growth and corporate profitability decline, they start to increase the yield or cost of providing new capital, which can slow issuance, as borrowers are less inclined to refinance existing bonds. If investors start to become significantly concerned about borrowers’ ability to pay, issuance could stop all together. Monitoring pricing and issuance activity can be a helpful indicator of how investors and borrowers are viewing economic and corporate profit growth.
From a pricing standpoint, yields on high yield new issues in April increased 0.32% to a three year high of 7.28%. This is a sizeable increase from the all-time low of 4.99% in September 2021. The current ICE B of A index yield (which includes all outstanding bonds) was 7.60% as of May 17th. The spread of the ICE B of A index (the yield of the index above a similar duration Treasury) was 4.48% as of May 18th. These are the highest levels since Q4 2020 and a sizeable increase from the recent low of 3% at the end of 2021.
Source: ICE, Bloomberg.
This increase in spreads suggests that investors are starting to become more concerned about the outlook for credit as the rise in yields for high yield issuance has been more than the increase in Treasury yields. This concern about credit quality has been most apparent in the CCC portion of the index. These issuers are the lowest rated portion of the high yield market and are the most sensitive to changes in economic growth. Spreads for that portion of the ICE B of A index recently increased to over 1000 basis points for the first time since October 2020.
Source: ICE, Bloomberg.
This rise in yields is not just impacting costs, issuance has also started to decline significantly. Total volume of new issuance in April 2022 was the lowest since 2008, and year-to-date volume through April was the lowest since 2009. This is a decline of 73% compared to 2021. This has mostly been driven by a significant decline in refinance activity, which has declined by 83% compared to the same period in 2021. Refinancing activity has declined from 79% of issuance over the first four months of 2021 to just 53% in 2022 (for April 2022 refinancing activity was less 15% of total issuance).
Source: S&P Global Market Intelligence.
If capital costs continue to their current trajectory, it is unlikely that refinancing activity will pick back up. This will likely continue to work as a headwind for total issuance in 2022. If credit risk concerns increase as economic growth and corporate profits slow in the second of 2022, issuance could pause as investors become unwilling to provide new credit, or if costs increase to a point that borrowers cannot afford, they may delay trying to issue. This has started to occur in Europe where no high yield took place from February 9th to April 27th.
The current increase in spreads for high yield bonds is suggesting that investors are becoming more concerned about the outlook for economic growth and corporate profits. The decline in issuance so far has been a derivative of that increase, as refinancing activity has slowed. There are a limited number of outstanding issues maturing in the next 12 months meaning companies can delay taking on the increased borrowing costs for the time being.
If issuance continues to decline away from the refinance market, this could be a sign that investors are becoming less willing to extend credit. An inability for companies to access borrowing markets would likely create more negative headwinds for economic growth as companies would have to scale back spending and investment until credit markets become open and more affordable.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
*Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy or completeness of any information herein, nor does Bloomberg make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, Bloomberg shall not have any liability or responsibility for injury or damages arising in connection therewith.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC