High-yield credit spreads spike ‘could signal recession’

A SURGE in high-yield credit spreads to a two-year high has sparked fears that the market for risky debt is seizing up as central banks push up borrowing costs.

Junk bonds plunged in December amid concerns of a global slowdown and tightening financial conditions. The spread between high-yield bonds and Treasury yields has also widened as the recent oil price slump hit producers, which are often funded by issuing junk bonds.

The ishares Iboxx High Yield ETF slid 7.7pc in the final quarter of the year to hit its lowest level since February 2016 after suffering its biggest daily fall in almost three years in last week’s market slide. Gauges tracking leveraged loans – credit for the most indebted companies – have also slumped as risk appetite has diminished.

Weekly outflows from US leveraged loan funds and ETFS smashed records in December and have been “elevated for five consecutive weeks with a cumulative outflow of $9.4bn, or 8.7pc of assets”, Bank of America Merrill Lynch revealed. Reports have suggested that banks are struggling to find buyers for risky leveraged loans, a market which has been booming in recent years.

Neil Mackinnon, global macro strategist at VTB Capital, said credit market indicators suggest the Fed has made a policy error by hiking interest rates. He said: “The risk of curve inversion will trigger a tightening of loan standards and a pullback in bank lending growth that will squeeze the US economy.”

Mr Mackinnon highlighted that money markets “are pricing in that the peak in the US interest rate cycle is imminent”. He added: “The Fed might well have a stock-market and/or credit market crash to contend with.”

JP Morgan analysts have warned US high-grade credit spreads are “spiking as if a recession will begin in three months”.

The Treasury yield curve is also at its flattest since the financial crisis, hovering around 10 basis points away from inversion territory. An inversion – when short-dated Treasury yields are higher than those with a longer maturity – is seen as a key signal for a recession by investors and has predicted the last seven downturns.