Weekly Market Summary

Extra Credit^*

• U.S. interest rates have repriced substantially lower relative to other G10 (Group of 10) central banks since October's Consumer Price Index (CPI) surprise. The dovish repricing was reinforced by Federal Reserve Governor Christopher Waller’s recent remarks, which were interpreted as a signal the Fed could begin easing much sooner than previously thought. Along with negative month-end dollar flows and residual long position unwinding, this allowed EUR/USD to test 1.10. At current levels, however, risk-reward is shifting back in favor of the dollar.
• What is the implied default rate for high-yield bonds for 2024 based on current spreads? Using current spreads of 418 basis points, an excess spread of 309 basis points, and a recovery rate of 40%, the implied default rate for high-yield bonds is 1.81%, which is 94 basis points below the markets 2024 forecast of 2.75%. While the 30-year median excess spread is 309 basis points, the average excess spread has historically run lower or higher depending on the CBOE Volatility Index (VIX). For example, excess spreads average 470 basis points in a sustained 25 or more VIX environment. In 2023, spreads in the low 400s were accompanied by a default rate of 3%, a historically low VIX below 15, and an excess spread in the low 200s. We believe a historical average excess spread that is consistent with other slower growth backdrops will seep into valuations as rates remain restrictive and the cycle matures.
• What does this analysis indicate for implied default rates for leveraged loans? The loan-only issuer base now accounts for 3 out of 4 issuers in the marketplace, and this cohort has consistently exhibited lower recovery rates over the past decade (since 2008, the average recovery on loan-only defaults is 49% vs 63% for all loan and bond issuer defaults). Using an excess spread of 368 basis points and a recovery rate of 50%, the implied default rate for current loan spreads to maturity of 525 basis points is 3.13%, which is 12 basis points below the 3.25% default forecast for 2024.
• January has historically been a strong month for high-yield bond and leveraged-loan performance. January’s average high-yield bond return over the past 37 years of 1.59% exceeds the average for all other months by 103 basis points. Meanwhile, January’s average leverage loan return of 1.04% exceeds the average for all other months by 67 basis points, with returns positive 93% of time. Also notable is the strong performance in the back half of December and first half of January. The average return for high-yield bonds between mid-December and mid-January is 2%, or more than four times a typical 30-day stretch. As well, the average return for loans between mid-December and mid-January are 1.5%, or more than four times a typical 30-day stretch.
• Bank-loan and high-yield bond default rates, excluding distressed exchanges, finished the month at 2.01% and 2.08%, respectively, up from 1.89% and 1.76% from October. The long-term historical default rate for loans and high yield bonds is 3.1% and 3.2%, respectively.

Sources: Bloomberg and JP Morgan as of 12/4/23.