By Vicky Ge Huang
If the U.S. economy is headed for trouble, no one told the junk-bond market.
The premium that investors demand to hold debt from sub-investment-grade companies instead of relatively safe Treasurys has shrunk to near pandemic-era lows, a sign of dwindling worries about an economic slowdown that would cause a big jump in defaults and bankruptcies.
Low-rated debt has been swept up in a broad market rally fueled by signs of cooling inflation and hopes for interest-rate cuts. Attracted by yields around 8%, investors have added a net $3.7 billion into junk-bond funds so far this year, according to Refinitiv Lipper -- the first inflows in that period since 2020.
That demand has powered bond sales from companies including Jack Dorsey's Block and Carl Icahn's Icahn Enterprises in recent weeks. Collectively, low-rated businesses issued $131 billion of speculative-grade debt this year through mid-May, according to PitchBook LCD, up from about $71 billion during the same period of 2023.
Investors and analysts closely watch junk bonds because companies with weaker credit ratings tend to be hit by economic problems first. Strong demand there -- along with a recent surge in profits among S&P 500 companies -- boosts hopes that the economy will cool enough for rates to come down, without sliding into a recession.
"Markets continue to buy in that there will be a soft landing," said Matt Brill, head of North America investment-grade credit at Invesco. "The all-in yields are enticing buyers to invest, and there are few concerns about a declining economy."
Bonds of all kinds are rebounding after three straight months of hotter-than-expected inflation data rattled markets, denting investors' hopes for interest-rate cuts. Now, signs of cooling price increases have rekindled bets that the Federal Reserve could cut rates more than once this year, according to CME Group data.
Many companies are taking advantage of investors' demand to refinance existing debt. SS&C Technologies, which provides software for the financial-services and healthcare industries, recently issued $750 million of bonds that will mature in 2032 to help pay back floating-rate debt that was coming due as soon as April 2025.
Thanks to higher underlying interest rates, the bonds sold at a 6.5% yield, a percentage point more than the initial yield on the company's older bonds that were issued in 2019. Still, the premium, or spread, to Treasurys was 1.91 percentage points -- or a percentage point lower than the initial spread on the bonds sold in 2019. That suggests investors viewed the new bonds as less risky than the older bonds when they were first issued.
SS&C Technologies' refinancing effort also included a $3.9 billion loan, which was larger than initially planned because of stronger-than-expected demand from investors.
"We caught an opening for the timing for the refinancing," said Brian Schell, chief financial officer of SS&C Technologies. The company primarily used debt to finance mergers and acquisitions in the past.
Heading into the year, Allied Universal, a provider of facility services and security, had about $1.9 billion of secured debt due in 2026. In February, the company refinanced $1 billion of that debt, extending its maturity to 2031. More recently, it tapped the bond markets again for $500 million after seeing a softer-than-expected jobs report and a persistent tightening in spreads.
"It was an opportunistic trade for us," said Lasse Glassen, global chief communications and investor relations officer for Allied Universal. "We took advantage of good conditions."
There are signs of stress lurking. The default rate has ticked up to 5.8% of junk bond issuers over the 12 months through March, its highest level in three years, according to a Moody's Ratings analysis. That figure includes bankruptcies and out-of-court debt restructurings.
The rise reflects ongoing financial difficulties at some private-equity-owned companies that had struggled to refinance debt at today's higher rates, said Julia Chursin, a senior analyst with Moody's leveraged-finance and private-credit team.
Telecommunications and media businesses, which face challenges including cord-cutting and the shift to streaming services, are among the most at-risk sectors, she said.
"We are in this benign environment where everyone wants to earn a little bit extra yield and take a little more credit risk, but the credit risk is ticking up," said Kevin Loome, a high-yield portfolio manager at T. Rowe Price.
Still, technical factors could keep spreads on high-yield bonds relatively low. Over the past few years, more businesses climbed into investment-grade territory, or returned there, while fewer fell into junk. That cuts into the supply available for investors, analysts said.
"It's more money chasing the same amount of paper outstanding, and that's also been very supportive of the market valuations," said Michael Anderson, head of U.S. credit strategy at Citigroup.
--Sam Goldfarb contributed to this article
Write to Vicky Ge Huang at vicky.huang@wsj.com
(END) Dow Jones Newswires
May 21, 2024 23:00 ET (03:00 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
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