The announced interest rate cuts by the Federal Reserve will lead to lower yields on junk bonds. In other words, for a company with a very low credit rating, it will lead its debt to the category of “junk” bonds.
The question is whether investors will be willing to take on the greater risk of junk bonds in pursuit of higher returns, or whether they will back off in recognition of broader economic weaknesses to avoid risk.
Jerome Powell may have declared victory over inflation and claimed that we should expect looser monetary policy going forward, but with spreads (compared to the US 10-year Treasury note) on junk bonds not widening as much as expected by during a period of economic tightening, we have to wonder if money is actually still cheaper than the Fed’s latest round of hikes would have us believe.
The Chicago Fed’s current National Financial Conditions Index (NFCI) continues to verify this, with its numbers still in negative range, pointing to relatively loose financial conditions in early 2024.
Junk bond spreads have narrowed by an average of 38 basis points since September, reaching 343 basis points. There was an unusual distance between the spreads and the price of the dollar.
Government bond yields had generally risen. This time we had the exact opposite. In particular, given the concerns about persistent inflation that have so preoccupied the investing public for many years, the correlation between US Treasury yields and risk assets is in the same direction.
