The U.S. market for high-yield corporate bonds followed stocks higher on Friday after a disappointing jobs report bolstered hopes that more economic stimulus could be on the way.
The number of new jobs created in May reached only 75,000, well below expectations for a gain of 185,000 predicted by economists. While that could make it harder for workers looking for a paycheck, the immediate reaction was bullish for debt-laden companies.
Corporate debt rated below investment-grade, or so-called junk bonds, have made significant gains this week on surging expectations that the Federal Reserve will cut interest rates to help give steam to an economy shadowed by the prospects for a global trade war. Against this tense backdrop, the weaker-than-expected jobs report could energize bets for easier Fed policy and help bonds from leveraged issuers retrace lost ground.
“This was one of the most anticipated jobs reports in quite awhile,” said Matthew Kennedy, a senior portfolio manager at Angel Oak Capital Advisors. “With the equity markets and [high-yield] ETFs up today, that would back the impression that the market expects the Fed to cut.”
Inflows rebounded into the biggest exchange-traded fund tracking the performance of corporate bonds rated below investment-grade, after struggling with redemptions in the past few sessions. The iShares iBoxx $ High Yield Corporate Bond ETF HYG, +0.26% attracted $1.67 billion of inflows in the last two sessions, after shedding around $2.31 billion of assets in the five sessions since May 29, FactSet data show.
The premium investors pay to own a basket of high-yield corporate bonds over risk-free debt TMUBMUSD10Y, +2.45% , or the credit spread, has narrowed sharply in the last three days. The high-yield spread has fallen to 4.42 percentage points at the end of Thursday, after hitting a recent high of 4.70 percentage points on Monday, based on an index provided by ICE Data Services.
Market participants, in particular, keyed into remarks made by Fed Chairman Jerome Powell on Tuesday, suggesting that the central bank could ease policy if trade tensions persisted. Fed Gov. Lael Brainard, New York Fed President John Williams and Vice chairman Richard Clarida have also echoed Powell’s views.
Wall Street is placing a 25% chance of a rate cut in two weeks at the Fed’s June 18-19 policy-setting meeting, according to CME Group data. The chances for a cut by the end of July now sit at 90%.
The S&P 500 SPX, +1.05% and the Dow Jones Industrial Average DJIA, +1.02% are up more than 4.5% this week, after they experienced their worst May since 2010. Likewise, key high-yield exchange-traded funds were up 0.3% on Friday.
For junk bonds, the weaker-than-expected jobs number might just be the tonic the sector needs for a more sustained rally.
“The labor market will be the key gauge for the Fed as it decides what adjustments to make to monetary policy,” said Thanos Bardas, portfolio manager at Neuberger Berman.
Lower borrowing costs are a boon for speculative-grade companies, which seek to refinance debt in the bond market at the cheapest rates possible, such as California utility Pacific Gas & Electric Co. and Teva Pharmaceutical.
Refinancing activity since February has averaged $16 billion a month in the high-yield bond market, a spike from $7 billion a month between April 2018 and January 2019, according to JP Morgan data.
But many junk-rated companies also need a vibrant U.S. economy and global trade to sustain their businesses and keep abreast of debt payments.
“The jobs report is obviously an important indicator for the health of the U.S. economy, but unfortunately the U.S. economy in isolation is not the only thing we have to worry about,” said Maura Murphy, a co-portfolio manager of Loomis Sayles’ Inflation Protected Securities and Multi-Asset Income funds.
“We have to worry about the broader global picture. The global fears may dominate more than the U.S. jobs data.”
Despite potential headwinds, this week analysts JP Morgan bumped up their full-year total return forecasts for high-yield bonds to 12% from 10.5%, partly due to the expectation that the Fed will help salve any potential negative impact from the ongoing tariff wars.
“The yield chase is still on,” said Tracy Chen, head of structured credit at Brandywine Global. “People are still thinking of buying the dip, because you still have the Fed at your back.”