The U.S. economy has continued to thrive despite the Federal Reserve’s recent increase in interest rates, which are now at a 22-year high.
The “Grab for Yield” Trend
Mizuho Securities has identified a trend of investors seeking higher yields in stocks and riskier corporate bonds. This surge in demand is driven by the belief that the Federal Reserve’s efforts to bring inflation back to its 2% target will be successful, thereby avoiding a recession or a significant decline in the labor market.
No Broad Credit Crunch
The recent failures of Silicon Valley Bank and Signature Bank in March did not trigger a widespread credit crunch, providing further evidence that it is safe to pursue higher yields. Investors have regained confidence, resulting in a rise in yields within the riskier $1.5 trillion segment of the U.S. corporate-bond market.
Current Yield Levels
Despite the Federal Reserve’s ongoing rate hikes to combat inflation, yields in the riskiest segment of the corporate-bond market have stabilized around 8.5%, down from a peak of 8.9% in March. This signals investor confidence in the market’s ability to withstand potential economic challenges.
Stock Market Performance
While long-term Treasury yields have risen, causing a decline in stock prices during August, the S&P 500 and Nasdaq Composite Index have shown signs of recovery on Monday. Analysts at Goldman Sachs believe that if the U.S. economy continues on its current trajectory toward a soft landing, there may be room for further equity exposure.
In conclusion, despite the high interest rates set by the Federal Reserve, the U.S. economy remains robust. The “grab for yield” trend reflects investors’ confidence in the market’s ability to weather potential challenges and achieve stable returns.
The Rise of Treasury Yields Sparks Increased Interest in Junk Bonds
The benchmark 10-year Treasury yield was recently reported at a record high since 2007, reaching nearly 4.34%, according to FactSet^1^. This surge in yields indicates a significant portion of returns offered by junk bonds, in addition to a spread or premium to compensate investors for default risks^1^. Currently, the spread on the ICE BofA US High Yield Index is set at 4%^1^.
A noteworthy development is the diminishing spreads in junk bonds, even for the riskier Triple C class of these bonds. This trend demonstrates a growing willingness among investors to take risks with heavily indebted companies, despite receiving lower returns^1^.
The narrowing of spreads is exceptional, especially when considering the rise in speculative default rates from historically low levels. However, the default rates, currently at 1.43% as of August, remain well below what is indicated by the tightening standards in the Federal Reserve’s senior loan officer survey^1^.
In contrast to this escalating situation, U.S. high-yield funds have experienced outflows of $8.7 billion this year, relative to their assets under management^1^. These figures were reported by Goldman Sachs analysts, suggesting increased caution among investors.
Despite this caution, Strobach, a financial analyst, highlights two factors contributing to the continued interest in junk bonds. First, the stability of the U.S. dollar, which adds to the attractiveness of the grab-for-yield strategy. Secondly, he predicts that oil prices, including the price of the U.S. benchmark West Texas Intermediate crude, will remain near their recent upward trend, with the current price hovering around $80 a barrel^1^.
It is important to note that the significant weighting of the U.S. junk-bond index towards the energy industry further influences investor behavior and decisions^1^.
Related: Stocks Might Not Be Overwhelmed by Central Bank ‘Elephants’ According to UBS CIO^2^