Bloomberg News reports that aside from a move related to the bond spreads, when it comes to signaling early signs of an impending recession, a new canary exists in the credit coal mine. This is expressed by the strategist at Morgan Stanley, Srikanth Sankaran, in his new note. He says that traditionally in the credit market, the first to crack is the junk-rated economic bonds as the economy slumps. The same position is now being filled by floating rate loans worth more than $1 Trillion.
These loans, which are leveraged, were expected to be big game changers for the investors with rising interest rates since they tend to reset to keep up with the benchmark rates which the Federal Reserve sets. As such, they offer the probability of higher returns. The sale of loans escalated in the years that followed the financial crunch of 2008, while the banks on Wall Street have often highlighted the relatively resilient performance of these asset classes at that time.
But these asset classes have dwindled in the current year as the Fed has been raising the rates rapidly for decades. Even before 2022, concerns related to the riskiness of the loans that were being extended were rampant. Few analysts warn companies that have borrowed and are using leveraged loans are likely to be subjected to higher bills that might threaten the ability to repay.
Bloomberg News reports that according to Sankaran, the credit coal mine could be leveraged loans that are a little less “macro” but equally a vital part of the credit market. He also pointed out that the S&P/LSTA Leveraged Loan Index has managed to breach the 85 level only during the financial crunch of 2008 and even worse during the 2020-induced sell-off due to the pandemic. However, it is quite likely that the index might as well slide below the level even if there is a mild recession.
The market participants have been watching historically high-yield bonds for signals of an impending recession. The spreads range between 800 and 850 basis points and are usually considered to show a so-called “growth scare,” as Sankaran states to Bloomberg. However, the evolving junk bond market, which now encompasses a BB-rated debt preponderance, the highest quality designation in the category of high yields, indicates that the spread level must be watched closely to the 700 basis points, added the analyst.
He also concludes that the high-yield credit spreads are likely to be less than sensitive to a growth slowdown compared to the past. However, the loan market is vulnerable. Given the present valuations, the analyst said they maintain that a cautious approach across the corporate credit must be maintained, not just in seniority but also quality.
