FOMO on Junk Bonds Clashes With Recession Fear

US corporate bonds are posting one of their worst selloffs since the financial crisis and could deteriorate further if recession predictions prove accurate. But with junk-rated bonds yielding around 8.6%, it wouldn’t be out of the question to take a flier on a diversified basket of the securities. At these levels, the risks actually look somewhat balanced.

Corporate debt has a front-row seat for the showdown between the competing inflation and recession narratives dominating financial markets. The Federal Reserve’s efforts to lift interest rates and rein in the worst inflation in 40 years are intended to curb prices pressures, of course, but they may well topple growth in the process. The forces of growth and prices have strong but sometimes divergent impacts on corporate fixed income.

Consider that the yield on corporate bonds is essentially the risk-free government interest rate plus the premium — or spread — that the market demands to bear a company’s default risk. The first half of 2022 was largely about rising rates, but further signs of a recession could send that move in reverse. On the other hand, credit spreads have a real risk of widening if the economy goes south. It’s possible that one of the two forces will prevail, or they may just cancel each other out.