A month ago we saw the reinstatement of Ford Motor’s investment-grade (IG) status following almost four years as a high yield (HY) rated company. This came after S&P joined Fitch in upgrading the car company (Moody’s still rates Ford one notch below IG), with Ford’s bonds now included in all the main IG indices.
The upgrade means Ford is one of biggest rising stars ever and, as the largest HY issuer, the upgrade takes ~ $41bn of index eligible debt out of the ICE BAML USHY index. The welcome news is that Ford’s upgrade provides a positive technical boost for HY as index-tracking funds adjust their holdings and demand for replacement HY paper grows as investors look to rotate out of Ford’s bonds. The result is a positive ripple effect for the whole US HY market.
The technical from Ford’s rise to IG is part of a wider rising-star trend over the past three years. According to JPM, there has been a record $116bn of rising stars this year, following a prior record of $110bn last year, easily outstripping the amount of fallen angels.
US rising stars have now outpaced fallen angels for the third consecutive year. Whilst it is clear we will not see this trend continuing at the record levels seen over the past two years as we revert to fallen angels/rising stars being more balanced going forward, the cohort of rising star candidates is still sizeable. And with a year-on-year increase in supply still falling short of organic demand (calls/tenders/maturities/coupons), the high-yield bond universe has continued to contract amid 2023’s large imbalance of rising stars and fallen angels.
Indeed, with rising stars exceeding fallen angels by $111.4bn in 2023, the high-yield bond market is producing a huge supply deficit year-to-date following an unprecedented short-fall in 2022.The HY index is now just $1.3tn in size, down 16% from its peak in 2021 – this is a very strong technical for the HY markets.
One of the other main components to why the supply of HY bonds available will remain subdued is due to the continued expected lower levels of new issuance versus what the HY market is historically use to digesting. As we mentioned in our previous blog , the maturity wall for US HY is limited, the need for refinances is still low and companies may look to de-lever rather than issue at higher rates, which should keep primary market activity skewed towards refinancing.
New credit creation is running at very low levels as the cost of capital is prohibitively punitive, deterring issuers from coming to the market. BAML forecast HY gross new issuance at $165bn in 2024, a 5% drop from the projected $175bn for full-year 2023. This forecast implies HY issuance will be at half the average pace between 2012 and 2021 and one-third its peak level in 2020-2021. This outcome would aid a supply/demand imbalance and support credit spreads as the sheer natural demand for HY bonds outweighs the limited fresh supply.
The technical combination of a smaller USHY market, paired with limited supply should be a barrier to aggressive spread widening. Spreads should be somewhat supported even by the natural demand for HY outweighing supply.
However, it is also important to highlight that there is currently $5.76tn (+19.71% year-to-date) sitting in money market funds. If we see investors looking to extend duration and lock in higher yields at these levels, demand will increase dramatically on a smaller USHY market that is experiencing below historical average primary market activity. A combination that should bode well for credit spreads if economic activity does not deteriorate.