Junk Bond ‘Warning Sign’: One Day Late, One Dollar Short :: Elliott Wave International

Wall Street asks “Could things get worse?” for junk bonds. We asked this question last July. The answer was the same then…and now.

by Nico Isaac
Updated: July 28, 2022

The other day, as social media swirled about catastrophic heatwaves and vaccine-resistant variants of Covid, this Tweet about a different kind of crisis popped up (July 5):

So I dug a bit. Turns out, this isn’t a story about a single junk bond hitting nine-figure slippages. The panic button is officially on for the entire global junk bond industry. On July 26, a news source published this stark statistic:

“We have just completed the worst semester on record for bond investors. [There is] Panic in junk bonds… And it could get worse.

Added MarketWatch July 2:

“The high yield corporate bond market — often called “junk bonds,” a Wall Street nickname for corporate debt with less-than-stellar credit ratings — flashes a warning.

“At the close of trading on Thursday, the spread on the Bloomberg High-Yield Corporate Bond Index – a measure of the risk premium demanded by investors holding the bonds included in the index – had reached its widest level since July 2020.”

So, I dug a little deeper! And ended up digging into a much deeper truth.

If you look at the yield of CCC-rated junk bonds minus the yield of US Treasury bonds since the start of 2021, you’ll see this yield spread indicator hit a 15-year low of just 452 basis points in July. To translate: a narrowing of the spread is correlated with a preference for high-risk, high-return bonds over the safety of higher-quality bonds.

But this 15-year low in spreads was not reached in July…it happened last July, a year ago!

Notably, last July was also when Wall Street popped the cork off a candy bottle celebrating the new junk bond boom – right at the lowest in yield spreads in 15 years!

On July 14, 2021, CNBC stated, “The junk bond market is on fire this year as yields hit an all-time high,” and wrote:

Junk bonds aren’t so junky anymorewith a strong fundamental backdrop helping to support what has traditionally been one of the riskiest sections of financial markets.”

That is, many traditional experts did not see “flashing warning signs” – yet those signs did flash. You just had to know where to look.

In our July 2021 Elliott Wave Financial Forecast, we warned of an impending junk bond crisis and said:

“Historic levels of fiscal and monetary stimulus have led to a epic complacency among buyers of lower quality debt…

“Now investors are super confident that the Fed will keep everything from falling, including the junkiest of junk debt. It won’t, again.”

And now, a year later, in our July 2022 Elliott Wave Financial Forecast, we bring the chart of the CCC-rated junk bond yield minus the US Treasury bond yield to the fore and show that from the 15-year low in July 2021, the spread has more than doubled.

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This means that soaring bond yields (and falling bond prices) are now outweighing the ability of borrowers to issue those bonds, as investors now favor traditional safe havens over high risk ones.

Our July 2022 Financial forecast adds:

of June [2022] the total return of high yield bonds is -6.7%, which, with the exception of the market crash in March 2020, is the biggest monthly loss from the depths of the Great Credit Crisis in September, October and November 2008. It is even worse for CCC-rated junk bondswhere the loss in the first half was 16.4%, the the greatest ever recorded.”

Widely seen as the canary in the broader coal mining market, junk bonds are one of the first indications of whether the economy will sizzle or not emerge at all.

In addition, on July 21, the New York Times revealed that the yield curve among short-term and long-term government bonds is now inverted, confirming the futility of the Fed in preventing a bond price crash, as predicted in our July 2021 Financial forecast. From New York Times:

“Wall Street’s most talked about recession indicator is sounding its loudest alarm bell in two decades, heightening investor concerns that the U.S. economy is headed for a slowdown.”

“An inversion of the bond market yield curve has preceded every U.S. recession for the past half-century. It’s happening again.”

Right now July 2022 Financial forecast reveals what other signs are flashing to help you prepare for what’s likely to happen.

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