U.S. companies binged on debt when rates were super low, so they wouldn’t have to swallow the bitter pill of higher borrowing costs down the road.
The strategy has worked out well for most companies in 2023 as the Federal Reserve has quickly jacked up its policy rate to its highest level in 22 years.
Still, an “iceberg” could await corporations if the Fed keep rates higher for longer. Fears of that precise backdrop next year helped send the benchmark rate for the U.S. economy to its highest level since the fall of 2007, with the 10-year Treasury yield
BX:TMUBMUSD10Y
around 4.57% on Friday.
“The lagged effect of higher rates has been very pronounced in this tightening episode, since only a small share of corporate debt has been reset so far,” Oleg Melentyev’s credit strategy team at BofA Global said in a Friday client note. “All this tells us that what we observed so far is just the tip of an iceberg.”
Despite all the Fed already has done to fight inflation, many companies still benefit from ultra low pandemic rates, with only about 10% of the roughly $1.5 trillion U.S. junk bond market having seen rates reset this year, according to BofA Global.
Their data suggests roughly 10% of the high-yield, or “junk bond,” market has seen actual rate resets, below the 14% estimate for investment-grade corporate bonds, and about 13% for the leveraged loan market over the past year.
Read: A wrecking ball could hit leveraged loans if the Fed keeps rates high
“Not only those resets have been slow, but there was also a material quality skew in those who have chosen to reset: issuers with stronger fundamentals,” the BofA Global team wrote.
High-yield bonds have been a bright spot in the roughly $55 trillion U.S. bond market this year, where a jump in long-term yields since July has put the popular iShares 20+ Year Treasury Bond ETF
TLT
down almost 11% on the year so far and the iShares Core U.S. Aggregate Bond ET
AGG
down 3% in 2023, according to FactSet.
High-yield total returns were pegged at almost 6% on the year by Goldman Sachs researchers, versus close to -3.4% for 10-year Treasurys and the S&P 500’s
SPX
11.7% advance.
Despite the recent bond-market carnage, the two big U.S. junk-bond ETFs were positive on the year through Friday, with the iShares iBoxx $ High Yield Corporate Bond ETF
HYG
up 0.2% through Friday and the SPDR Bloomberg High Yield Bond ETF
JNK
0.4% higher, according to FactSet.
While yields are higher across the bond market, credit spreads aren’t. Tight credit spreads signal that bond investors aren’t yet too worried about the odds of hard landing for the U.S. economy or a deeply painful default cycle in this cycle. Rate cuts would also improve the outlook for borrowers with a wall of debt maturing in the next few years.
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