Junk-Bond Market Gets Riskier With Erosion in Credit Quality

The $1.4 trillion US junk-bond market is getting junkier, as more debt gets either downgraded or elevated out of the high-yield universe altogether, leaving greater potential risks for investors.

Credit quality is starting to erode as pandemic-fueled “seismic changes” that altered the mix of the high-yield market are now reversing, according to Barclays Plc strategists.

Higher-rated junk bonds, those in the BB tier, are returning to investment-grade as large companies that were downgraded amid the disruptions of Covid-19 improve their balance sheets. But more bonds in this tier are also facing ratings downgrades, too.

As a result, the share of this debt represented in the benchmark Bloomberg US Corporate High-Yield Bond index has declined. At the same time, bonds rated in the B tier, around the middle of the junk spectrum, accounted for a higher proportion of junk supply in 2023, strategists led by Brad Rogoff wrote in a note this month. That tier of debt has become a larger proportion of the index since 2021.

“Index quality is beginning to deteriorate,” the Barclays strategists wrote. “This shouldn’t change the outlook for default amounts in notional terms, but it does make the case that default rates could be higher.”

Junk Bonds Get Junkier