Corporate bond yields have climbed to their highest levels in years on relatively high and sustained interest rate expectations and a corresponding rise in Treasury yields. And while steady spreads on these bonds signal a stable view on credit risk, the jump in interest rates is adding more pressure on corporate borrowing.
The yield on the S&P US Investment Grade Corporate Bond Index settled at 6.14% on Oct. 13, just 15 basis points down from Oct. 3 when the yield settled at the highest point since 2009. Meanwhile, the S&P US High Yield Corporate Bond Index settled at 9.4% on Oct. 13, down from 9.57% on Oct. 6, which was the highest level since April 2020. Investment-grade yields have jumped about 450 basis points since the end of 2020 while high-yield rates have jumped nearly 500 basis points over the same time.
These surging corporate yields, which translate to higher costs for companies issuing new bonds, are a potential signal of the rising probability of a significant recession, one the US economy has so far managed to avoid as the domestic labor market remains robust and spending continues despite 11 separate rate hikes from the Federal Reserve since March 2020.
"Higher yields mean that corporates are facing a higher cost of funding, and the longer they stay high the higher the probability for a hard landing," said Althea Spinozzi, a senior fixed income strategist with Saxo Bank. "Therefore, it increases the risk of default for cash-strapped companies and those with large upcoming maturities."
Government debt yields drive higher
Rising yields indicate investors are demanding greater returns for the risk of holding corporate bonds and could suggest trepidation in the market about rising defaults. Yet much of that rise in yield stems from movement in the Treasury market rather than the spread, a premium for holding riskier corporate debt than the safe-haven US government debt.
"A lot of the rise in yields is just a rise in sympathy with the moves on Treasury yields," said Joel Prakken, chief US economist at S&P Global Market Intelligence.
The yield on the benchmark 10-year Treasury bond yield settled at 4.81% on Oct. 3, the highest level since 2007, amid expectations that the Fed planned to keep rates higher for longer as inflation remains stubbornly above the central bank’s target.
"The Fed's more hawkish longer-term outlook is one factor driving corporate yields higher," said John Canavan, lead analyst with Oxford Economics. "Corporates generally trade with a spread to Treasuries, so the overall rise in Treasury rates has been a major influence on the rise in corporate debt."
Treasury yields have climbed on views of the Fed's "higher for longer" rates policy, the rise in supply of government bonds, the resilience of the US economy, and uncertainty about inflation, Canavan said.
Spreads hold steady
Still, spreads on corporate bonds remain largely unchanged.
The option-adjusted spread in the S&P investment-grade bond index was 110 basis points on Oct. 13, lower than it has been for much of the year. Spreads are also lower than they have been for riskier high-yield bonds, suggesting investors have confidence in less creditworthy companies despite the slowing economy.
The option-adjusted spread in the high-yield corporate bond index was at 410 basis points Oct. 13, about 23 basis points lower than the start of the year.
"Luckily enough, companies were able to roll their debt into the future just after the COVID pandemic, and therefore maturities are not picking up until the second half of 2024," Saxo Bank's Spinozzi said. "However, the risk of default is not removed, because weaker companies needing to raise cash to finance existing operations will face tougher credit conditions, hence [are] more likely to default."