Is it risk on or risk off? This year has seen a string of trades on riskier bonds blow up, from emerging markets to Italy. But the high-yield market is sending the opposite message: That growth is here to stay.
High-yield corporate bonds are outperforming other fixed-income securities, and perhaps surprisingly, it is the riskiest bonds posting the biggest returns. Triple-C-rated global bonds—those most exposed to the risk of default—have returned 3.5% so far in 2018, according to ICE BofAML indexes.
Meanwhile, the overall spread between global high-yield bonds and Treasurys, at 3.66 percentage points, has rarely been tighter since the global financial crisis. In the cornerstone U.S. market, the spread has modestly tightened this year.
That matters because high-yield corporate bonds should be among the most sensitive assets to any deterioration in the growth outlook or tightening in financial conditions. The key risk for investors is of defaults that lead to permanent loss of capital.
However, defaults are low and investors seem to believe that picture will persist. Standard & Poor’s said in May it expects the default rate in the U.S., the biggest high-yield market, to decline to 2.5% by March 2019 from 3.4% in March this year.
This calm can’t be taken for granted. A record 42% of investors thought companies were overleveraged in June’s BofAML global fund manager survey. Other markets have had a rude awakening to risk in 2018.
However, for now the resilience in high-yield markets is a sign that global growth is still on track and that upsets in Italy and emerging markets can be contained. This canary in the coal mine is still singing.
Write to Richard Barley at richard.barley@wsj.com