Paul R. La Monica

Stocks may be a little more volatile lately due to concerns about tariffs and some recent indications of weaker consumer spending. But the bond market continues to send signs that the U.S. economy is doing just fine. How long it stays that way remains to be seen.

Risky junk bonds have rallied this year. The SPDR Bloomberg High Yield Bond exchange-traded fund is up 1.4% this year, only slightly trailing the 1.6% gain for the iShares iBoxx $ Investment Grade Corporate Bond ETF.

The difference in yield for junk bonds and investment-grade debt has narrowed, too. The yield for the iShares iBoxx $ High Yield Corporate Bond ETF is 5.9% compared with 4.4% for its investment-grade counterpart. What's more, longer-term Treasury bond yields have only edged slightly lower lately. It's another sign that investors are betting there won't be a recession soon.

"The credit markets and Treasury markets are not fully sold on a slowdown yet," said Emily Roland and Matt Miskin, co-chief investment strategists with John Hancock Investment Management, in a report Monday.

It's also worth noting that bonds near the lowest rung of the credit-quality spectrum, triple-C rated issues, have been barely rattled by recent stock-market jitters.

The BondBloxx CCC-Rated USD High Yield Corporate Bond ETF fell only slightly Friday even as the Dow Jones Industrial Average and S&P 500 suffered their worst daily loss of the year due to weaker-than-expected manufacturing data, home sales and consumer sentiment and a disappointing outlook from Walmart earlier in the week.

"Even the worst-rated U.S. corporate bonds aren't worried about a recession," said Nicholas Colas, co-founder of DataTrek Research, in a report Monday. Colas pointed out that spreads between CCC-rated bonds and Treasury bonds of similar duration are near their lowest in 10 years.

So what does that mean for investors? Colas thinks investors should be willing to take on more risk, noting that the strength of the junk bond market "continues to reflect a remarkable level of optimism."

"That is a reassuring message for equity investors and especially now given greater macro uncertainty," Colas wrote.

It may be a sign that investors should consider more risk in fixed income as well. Hunter Hayes, chief investment officer and portfolio manager with the Intrepid Income Fund, said in an interview with Barron's that the resilience of junk bonds makes sense when you consider that many companies were able to refinance debt back in 2021 during the middle of the Covid pandemic and lock in lower rates.

Hayes said that was the "financing of the century" and it has boosted the outlooks for many companies with riskier credit profiles.

"We feel pretty strongly that high yield is the best corner of the fixed-income market," he said.

That may be true for now. But investors still need to be on their guard for any further signs of economic weakness. Riskier bonds (and stocks) could reverse course quickly if recession alarm bells start ringing again.

"Corporate credit markets have shown remarkable stability despite recent equity and rates volatility," said Lawrence Gillum, chief fixed-income strategist for LPL Financial, in a report earlier this month. Gillum added that the resilience of CCC bonds shows that "investors are showing unusual comfort with credit risk across the quality spectrum."

Gillum warned that credit spreads could widen if concerns about the U.S. launching more tariffs on China, Europe, and other nations.

"A repeat of Trump 1.0 trade dynamics could bring heightened volatility to credit markets, which enter this period with significantly tighter spreads," Gillum wrote, adding that "it wouldn't surprise us if spread volatility increased from currently very low levels."

So it may not take much to shake investors in junk bonds and stocks from their complacency.

Write to Paul R. La Monica at paul.lamonica@barrons.com

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February 24, 2025 15:37 ET (20:37 GMT)

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