Why isn’t it falling? Worries in the US bond market: The market is too strong!
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The U.S. credit market is showing signs of overheating, with investors scrambling to buy corporate bonds even though yields have dropped to multi-decade lows by some measures. This frenzy has some on Wall Street worried that the market is priced for perfection and faces correction risks.
On September 29, according to media reports, ample market liquidity has fueled record-breaking corporate bond issuance. Investment-grade companies sold $210 billion worth of bonds in the U.S. market this month, setting a new record for the busiest September ever. The spread between investment-grade corporate bonds and U.S. Treasuries fell to 0.74 percentage points in September, the lowest since 1998. Junk bond spreads are around 2.75 percentage points, close to the historic low set in 2007.
Recently, two sudden bankruptcies in the automotive sector have sparked discussions among bond investors and analysts about deeper issues facing U.S. borrowers. Analysts pointed out that while these events have unique causes and have not yet shown broader contagion, persistent inflation and rising default rates in private credit are enough to keep seasoned traders vigilant.
Barclays high-yield bond analysts compared the current situation of excessive valuations and emerging stress signals to the trash compactor scene in Star Wars, "where the four walls are closing in."
Meanwhile, private credit is seen as the biggest risk source on Wall Street, with the private credit market rapidly approaching $2 trillion in size, but default rates are rising, and 11% of business development company loans are using payment-in-kind interest.
Excessive Valuations Trigger Market Concerns
The core concern on Wall Street is that corporate bond valuations are unusually high, potentially masking excessive market behavior and failing to adequately compensate investors for the risks they bear.
The extra yield on investment-grade corporate bonds over ultra-safe U.S. Treasuries, known as the spread, has fallen to extremely low levels. According to ICE Data Indices:
This spread fell to 0.74 percentage points in September, the lowest since 1998. Junk bond spreads are about 2.75 percentage points, close to the historic low set in 2007.
Bond prices keep rising because investors—from individual retirement savers to large pension funds—expect that if the Fed continues to cut rates, yields will fall even further.
Although current rates are slightly below 2007 levels, they remain above the subdued levels seen for most of the past decade. Investors hope to lock in current rates, and this strategy could continue to drive demand.
Dan Mead, head of the investment-grade bond syndicate at Bank of America, stated: "There is still a lot of cash that needs to be deployed."
According to Dealogic, investment-grade rated companies have sold $210 billion worth of bonds in the U.S. market this month, making it the busiest September on record.
According to earlier reports, private equity firms such as Silver Lake are in advanced talks to acquire Electronic Arts for around $50 billion, which could become the largest leveraged buyout deal in history.
Howard Marks, co-chairman of Oaktree Capital Management, stated:
"There has long been a very positive investment environment, with abundant capital and high optimism, which can lead to high prices and deteriorating quality. The worst loans are often made in the best of times."
Bankruptcy Cases Expose Potential Risks
Lending to higher-risk borrowers has been increasing for years, first via traditional bonds and loans, then through the resurgence of private credit and complex asset-backed debt.
The longer the credit boom lasts, the more likely default rates will rise. Likewise, the higher corporate bond and loan valuations go, the more vulnerable they are to sell-offs.
It was reported that two sudden bankruptcies in the automotive sector have sounded the alarm for the overheated credit market, revealing the underlying fragility behind rapid growth.
Subprime auto lender Tricolor Holdings filed for bankruptcy and began liquidation this month, after its securitization partner, Fifth Third Bank, disclosed a $200 million loss due to warehouse loan clients' alleged fraud, later identified as Tricolor.
Over the past five years, the company raised about $2 billion in asset-backed securities. After the bankruptcy filing, some of its bonds traded for as low as 20 cents on the dollar.
A few days later, auto parts supplier First Brands Group sought bankruptcy court protection for some affiliates, after lenders questioned the company's accounting practices on its $6 billion in debt.
Elen Callahan, head of research at the Structured Finance Association, noted that Tricolor, as a "buy here, pay here" lender, also serviced its own loans, lacking third-party vehicle valuation, debt collection, or vehicle reselling, which could create "control issues" and "leave room for bad actors."
Rising Private Credit Default Rate Pressures Market
Some analysts believe private credit faces the greatest risks. The private credit market was almost nonexistent a decade ago but is now quickly approaching $2 trillion, becoming an area where risks are most concentrated.
This market is dominated by private fund managers like Apollo Global Management and Blackstone, which mainly lend to companies but also to consumer and real estate borrowers.
An increasing number of companies that have received private credit loans—especially small businesses—lack the cash flow to pay debt interest and have begun issuing IOU-like instruments to creditors, paying "payment-in-kind" (PIK) interest in place of cash.
According to S&P Global Ratings, as of the end of 2024, about 11% of business development company (BDC) loans are accepting PIK interest, and that's before tariff threats brought new uncertainties to U.S. companies.
More worrying is that the private credit default rate, which had dropped after spiking during the pandemic, is now rising again. According to Fitch's private monitoring, the default rate reached 9.5% in July before edging back down.
Nevertheless, some investors note that if inflation pressures ease and the labor market does not deteriorate further, allowing the Fed to stimulate activity through rate cuts and ease borrower pressures, the current benign environment may continue.
Joe Auth, head of developed fixed income markets at asset management company GMO, commented:
"I thought September would be very challenging, but I was wrong. I don't understand why everything is holding up so well—it's strange."
Risk Warning and DisclaimerThe market carries risk, and investments require caution. This article does not constitute personal investment advice and does not take into account the special investment objectives, financial situation, or needs of any individual user. Users should consider whether any opinion, viewpoint, or conclusion in this article fits their particular circumstances. Investments made accordingly are at one's own risk. ```