Amid the relentless rise in interest rates and inflation expectations, finding coupon income becomes even more crucial. Despite news report of a considerable amount of outflows from bond funds, the option-adjusted spread (OAS) of US investment grade and high yield corporate bonds remains nearly unchanged year to date. In contrast, their yield to worst (YTW), the lowest possible yield an investor would receive on a bond without defaulting, has risen slightly. The divergence between YTW and OAS in the credit space points out that any fall in price within the corporate space is mainly due to technical repricing over their benchmark. Still, the perception of risk has not changed. Looking at the US high yield corporate space, it is possible to note that the YTW has also barely moved, meaning that demand for riskier securities remains sustained despite US sovereigns continue to tumble.
The primary corporate bond market speaks for itself, indicating that it is not time to worry about a widespread selloff in the credit market because demand continues to be supported. Indeed, although last Wednesday the US high-grade bond issuance paused for a day, the successful issuance of Verizon’s jumbo bond deal on Thursday has revived corporate bond supply. However, it is important to note that high-grade corporate bonds are at a much greater risk of repricing due to their extremely heavy duration, making these securities more sensitive to changes in interest rates. As a matter of fact, while US investment-grade corporate bonds offer an average of 2.2% in yield for a duration of 8 years, the high yield bond market can offer double the yield for less than half the duration, just 3.5 years.
While we might see some signs of tiredness in the investment-grade market, this sentiment is yet not leaking to the high yield bond market for the simple reason that junk is the only asset that enables investors to lock in a yield higher than inflation expectations minimizing duration. This month, US Junk bonds are just $9 billion shy to break the monthly record issuance ever recorded. So far, around $27 billion were already sold in the month of March. On top of it, junk bond issuers can tighten spread significantly during the selling process as demand continues to be elevated.
It is becoming clearer and clear that we are witnessing is a duration event, which penalizes long maturities over credit risk.