Gavekal Capital: Junk Bond Spreads Hit New Cycle Low

Tuesday, November 5, 2013

Junk Bond Spreads Hit New Cycle Low

The spread between junk bond yields and the yield on the 10 year treasury bond hit a new cycle low yesterday, confirming the strength we've seen in the equity markets. Historically, junk spreads have been able to go go as low as 250 basis points, but with nominal rates this low we wonder if this pattern will be repeated this time around. Holders of junk bonds are already barely getting paid for their credit risk (the historic default rate on junk bonds is 5% and nominal junk bond yields are 5.67%), unless of course something has changed and junk bond default rates are set to level out at a permanently lower plateau. Remembering that profit margins are 1) cyclical and 2) near an all-time high (thus pushing down corporate defaults) we doubt this is the case, however.