Risky corporate bond trade increases amid cooling inflation

Recent data showed that the trade volume of risky corporate bonds in the U.S. had increased since the start of 2023 as the economy showed signs of cooling inflation.

ICE Data Services revealed that U.S. speculative bond yields had dropped by 80 basis points to slightly over eight percent within the first two weeks of 2023, indicating an increase in the debt asset. At the same time, the borrowing costs for groups with low credit scores decreased significantly by 300 basis points to 19.3 percent.

According to other data, the yield gap between junk bonds and Treasury notes has continued to shrink since the beginning of this year, signaling that investors return to bet on a more conducive economic environment and lower risks of default.

The progress also partially reflects a rebound in the U.S. Treasury notes, driven by expectations that the Federal Rates will ease its hawkish monetary policy. The drop in benchmark Treasury yields has made lower-rated corporate bonds more appealing to investors, as they usually offer higher yields.

The spread of the U.S. high-yield bonds shrunk by 50 basis points to 4.29 percent percentage points from the end of December to January 12. Meanwhile, the spread of the most affected junk bonds narrowed by nearly 300 basis points to just below 16 percentage points.

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UBS chief of credit strategy Matt Mish said investors were surprised by the downside trend of inflation. According to inflation data released last week, the U.S. consumer price index fell by 6.5 percent in December, a sixth consecutive drop.

Despite the signs of slowing inflation, Mish said the market was more focused on how inflation data would affect the Federal reserve's monetary policy. Furthermore, he added that there were still data contradictions in the market.

Recent data showed that the U.S. Treasury yield curve — the gap between two- and 10-year Treasury yields — was still inverted. An inverted yield curve typically warns investors about an extended economic contraction.

Lehmann Livian Fridson Advisors chief investment officer Marty Fridson said it was likely for a significant spread widening to happen this year. However, Fridson predicted the Treasury rates would stay relatively high and offset the recent growth. The investment officer added that the high-yield bond market was not a reliable source of data to predict a recession.

"It's typical that people seem to stick with it, maybe overstep their greeting and think, 'well, I'm going to get out before everyone else does,'" Fridson said.

Meanwhile, Mish said tightening spreads at the end of this month could predict an upward trend in the bond market for the rest of the year.

U.S. consumer prices, Fed's policy

Falling energy prices, especially gas, contributed to a lower December CPI. Overall, prices for essentials fell by 0.1 percent on a monthly basis. Certain food items, like bananas and oranges, reported a decline in the month.

Despite that, economists have warned that falling prices in certain sectors may not spread to others. Clothing prices, for example, increased by 0.5 percent in December from the previous month. The year-over-year price growth for clothing in December was 2.9 percent.

Principal Asset Management chief global strategist Seema Shah called the recent inflation report "a little underwhelming."

"Taking a step back, evidence is building that inflation is cooling and will continue to do so over the coming months," Shah said. "But perhaps the real question will come in late Q2 as inflation tries to move below the 4-4.5 percent handle."

Fed chief Jerome Powell said the central bank would start loosening its tight monetary policy to see the full effect of its hawkish interest rate hikes. The Fed's decision to increase benchmark interest rates to control inflation was met with concerns as uncareful policy-making might tip the economy into a recession.