Is The High Yield Bond Market Sending A Recessionary Signal For The U.S. Economy?

By | October 12, 2015

In other words when it comes to high yield bond spreads and the strength of the U.S. economy, is a nod as good as a wink to a blind man?

Yesterday an article at the Hallmark Abstract Service blog spoke to the high-end real estate market in the United States and whether sales above a certain dollar amount were flagging.

And now this article concerning whether the high yield bond sector of the fixed income market was sending recessionary warning signs for the U.S. economy? Why, you may be asking yourself, all of this negativity?

For the record the last thing that my business, one that relies on a vibrant and healthy real estate market along with a thriving consumer base needs, is a recession!

That said, the second-to-last thing that any business owner or strategic planner should be doing is sticking their heads in the sand ignoring a potential reality that may be looming around the corner.

As an example, forecasting in anticipation of making strategic decisions that concern capital expenditures such as bringing on new staff, buying a building or entering a new market should be done in the context of expected economic growth.

Prior to 2008 when I started my business, the good times were rolling in real estate and few saw any reason why the party should or would ever end. But end it did with a financial crash, and those businesses who spent freely assuming the music would never stop found themselves left without a chair. The fiscal consequences for many was dire!

So with all of that said a recession may or may not come but…

Is The High Yield Bond Market Sending Any Signals?

From an article at Business Insider, ‘The US economy is at risk, and the warning is coming from ‘the lowest of the low‘…

A dark corner of the bond market is sending a warning sign about the economy.

“If our analysis is correct, today’s elevated level of US investment-grade and high-yield credit spreads will persist, and default rates may rise materially through 2016,” UBS’s Stephen Caprio said on Wednesday. “The implication for the US economy is that wide credit spreads and ascending downgrade and default risks will increase borrowing costs for US corporates. This signals a downside growth risk to the US economy.

This story is not just about junk bonds. It’s about the junkiest of junk bonds and what they’re predicting for bank lending, which is critical for job creation.

Let’s take a breath and unpack this for a second…

The ‘lowest of low quality issuers’ are sending a warning sign

Caprio thinks we’re heading for a period of tighter, more expensive money. In a note to clients on Wednesday, Caprio observed that what happens in nonbank lending markets like the bond markets lead what happens in bank lending.

He homed in on a segment of the junk bond market.

“Our analysis suggests it is actually the lowest of low quality issuers (B-rated and below) that provides the first leading signal that credit stress may lie ahead, as Figure 3 illustrates,” Caprio wrote. “Worryingly, this chart is flashing red. While BB net issuance has held in quite well, B-rated and lower net issuance has plunged in a replay of late 2007, as investors cut back in the face of growing default risk and rising illiquidity.”

“And stripping out the energy sector from this chart makes no difference; ex-energy low-rated issuance is drying up too,” he added…

…”In sum, we believe that non-bank lending standards illustrate an overall tightness in US financial conditions that signal a downside growth risk to the US economy,” Caprio said. “While bank lending standards are healthy, we ultimately believe this misdiagnoses the pulse of the corporate credit cycle. Nearly all of the additional financing provided to nonfinancial corporates has come from non-bank sources, post-crisis. And expecting the banking system to meaningfully pick up the baton from a non- bank slowdown is unrealistic in today’s highly regulated environment. In short, non-bank liquidity has been the main driver of the corporate credit cycle post-crisis, and there are now early signs that it is evaporating.”

The full article can be read at the link above.

Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at

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