Aug 12, 2021 - Economy

A bond market peak

Data: ICE BofA via FRED; Chart: Axios Visuals
Data: ICE BofA via FRED; Chart: Axios Visuals

Financial markets have hit a lot of peaks this year — everything from monster year-over-year earnings, unprecedented fiscal and monetary policy support, and weekly stock market milestones.

Driving the news: Corporate bond prices were no exception — leading to record low yields. But that trend has started to reverse course.

Why it matters: "The bond market is the market of truth. And it's very clearly signaling that we’re hitting peak everything," Steven Boothe, fixed income portfolio manager at T. Rowe Price, tells Axios.

  • In other words, don’t be surprised if market momentum slows down in the second half of the year. "We are going to start coming off some of these peak fundamentals, and I suspect we'll start to come off of peak valuations as well," he adds.

What happened: Brent Finck, global co-head of high yield at Aviva Investors, says, "July was a bit of a reversal from the first half of the year. It felt like sentiment had shifted, and the risk-taking environment had changed a bit."

  • Uncertainty over the impact of the Delta variant, and fear that "we are now already at 'peak growth,' and economic conditions may soften quicker than previously anticipated" in part drove the shift toward risk-off in high yield, Finck says.
  • Historically, the high yield market has been highly efficient in predicting periods of overall market stress down the road — especially when the riskiest, lowest-rated bonds come under pressure, he adds.

Yields on those lowest-rated bonds have shot up over the last month. The "CCC rated and lower" segment of the ICE BofA high yield index is now yielding 7.4%, up materially from its record low 6.5% on July 7.

  • That doesn't mean we're in for a massive market correction. Yields still remain low by historical standards. But it is a sign that market froth has receded from its sugar high.

Be smart: Bond prices can only go so high. Unlike stocks, which theoretically have no ceiling, companies eventually repay the money they owe to bondholders — but no more than that.

The bottom line: At a certain point, the only direction bond prices can move is lower. We may have reached that point.

  • Low bond prices were a buying opportunity last year. "But the expectation for spread compression has gone away, and now portfolio managers are thinking of high yield as an asset class that provides solely a stream of interest payments," Finck says.
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