The U.S. corporate bond market has been exceptionally active recently, with substantial capital inflows driving activity, yet yield levels have fallen to multi-decade lows, sparking concerns among Wall Street professionals about excessive valuations and mounting risks.
Data reveals that U.S. investment-grade corporate bond issuance reached $210 billion in September, setting a new monthly record. High-yield bond issuance remained level with last year's figures, though the proportion used for leveraged buyouts has increased. Traders are concerned that this combination of "excess liquidity and elevated valuations" could trigger rapid sell-offs once negative news emerges.
Warning signs are already materializing. This month, subprime auto lender Tricolor Holdings faced allegations of financing fraud, leading to the collapse of approximately $2 billion in asset-backed securities, with some bonds trading at just 20 cents on the dollar. Days later, auto parts supplier First Brands filed for bankruptcy, intensifying market concerns about corporate financial transparency and leverage usage.
The broader risk lies in the private credit market's rapid expansion to nearly $2 trillion, accompanied by rising default rates. S&P data indicates that by the end of 2024, approximately 11% of business development company loans had converted to "payment-in-kind" (PIK) status, where borrowers use debt instruments instead of cash to pay interest. Default rates monitored by Fitch surged to 9.5% in July.
Spread levels also suggest investors are not receiving adequate compensation. ICE data indices show that spreads between investment-grade bonds and U.S. Treasuries have narrowed to 0.74 percentage points, the lowest since 1998. High-yield bond spreads of approximately 2.75 percentage points approach the extremely low levels seen before the 2007 financial crisis.
Analysts note that if inflation moderates and labor markets avoid further deterioration, the Federal Reserve may reduce financing pressure on companies through rate cuts. However, with interest rates still elevated and economic growth slowing, the contradiction between market overheating and rising defaults continues to build.
Oaktree Capital co-founder Howard Marks warns: "The worst loans are made at the most optimistic times."
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