Junk Bond Market Shrinking Paves the Way for Quality Debt

It appears that junk bond issuance has almost come to a screeching halt, according to a Financial Times article. This could pave the way for more fixed income investors heading towards the safety of quality debt, especially if the threat of a looming recession continues.

Per the FT article, the junk bond market shrank by $200 billion after hitting a zenith in the latter part of 2021 before heading into a 2022 fraught with rate hikes and increasing inflation. Of course, that put heavy downward pressure on the bond market as the Fed tightened monetary policy in order to contain inflation.

This, in turn, made companies think twice about new bond issuance in the high yield market. Investors looked to add more quality as they turned down the risk dial on higher-yielding debt.

“A steep rise in interest rates since early last year has helped deter companies from selling new bonds, while several companies have climbed out of the high-yield market into investment grade territory,” the FT article acknowledged.

This also made for out-of-the-ordinary picks by fund managers in high yield as options became less available. This, however, did help to prop up junk bond prices in the meantime, “even though many market participants continue to anticipate some form of economic slowdown,” the FT report added.

Still, that could present issues when it comes to the true valuations of these junk bonds. The result could be over-optimism, leaving investors in this debt vulnerable should the economy experience a recession.

A Broad, Quality-Oriented Option

“Those dynamics are threatening to give overly positive signals about the health of the economy, some investors believe,” the FT report said further. “They are also potentially lining up the bond market for a sharper decline if the outlook darkens — particularly those of lowly rated companies that failed to extend the maturity of their debt when money was cheap.”

“It’s asymmetric,” said Marty Fridson, a veteran high yield investor and chief investment officer at Lehmann, Livian, Fridson Advisors. “These conditions can cause the market to be overvalued, but they don’t protect you from a huge sell-off and a gapping down in prices when things turn around.”

As mentioned, the threat of a recession still puts quality debt into the forefront for investors. As such, the Vanguard Total Bond Market Index Fund ETF Shares (BND) offers an all-inclusive approach to getting core exposure to investment-grade debt.

BND, with its low expense ratio of 0.03%, seeks the performance of the Bloomberg U.S. Aggregate Float Adjusted Index. The index is well diversified with its mix of public, investment-grade, taxable, fixed income securities in the U.S. It includes government, corporate, and international dollar-denominated bonds. It also includes mortgage-backed and asset-backed securities, all with maturities of more than one year.

With BND, fixed income investors don’t have to sacrifice yield while getting quality exposure. As of July 11, the 30-day SEC yield is 4.47%.

For more news, information, and strategy, visit the Fixed Income Channel.