In another potentially bearish sign, junk bonds are getting dumped.
The Barclays High Yield Bond Index ($JNK.IV) closed at its lowest price in 2-1/2 years yesterday. The decline came despite modest gains in risk-free Treasury securities ($IDCT20RT) this month.
The risk premium, or “spread,” is also the highest in almost two years. Data from the St. Louis Federal Reserve and ICE shows junk bonds yielding 4.25 percentage points more than Treasuries as of Monday.
Remember that yields rise when prices fall. The recent selling in junk bonds, contrasted with gains in Treasuries, shows investors have less risk appetite. Higher yields also reflect worries about a potential rise in corporate defaults and bankruptcies over the medium term.
There are a few takeaways. First, troubles at once-mighty General Electric (GE) and California utility PG&E (PCG) have roiled the bond market lately. The specter of credit downgrades for either could increase the supply of junk bonds. That, in turn, has weighed on prices.
Second, the selloff in oil has taken a toll because the index includes plenty of speculative drillers and “frackers.”
But wider spreads may also reflect worries about a recession. After all, they remained below 4 percentage points all of 2018 — even when the market crashed in February and mid-October. Now in just the last few sessions they’ve shot through that level.
The change is also consistent with the latest commentary from Federal Reserve officials like Jerome Powell and Richard Clarida. Click here for more on their rapidly changing message.
Still, let’s keep it in perspective because spreads were much closer to 6-8 percentage points back in 2016 and are pretty much inline with historical averages. We just wanted to keep an eye on this because sometimes junk bonds are viewed as a forward-looking indicator.