(Bloomberg) -- While credit markets rally in anticipation of lower interest rates, a junk bond guru is warning that risky debt may underwhelm.
“High-yield investors who hope for a boost from Fed interest rate cuts over the next several months — which appear likely, although not certain — will have to adjust their expectations regarding the size of the boost,” Marty Fridson, whose debt analysis has been studied by Wall Street for decades, wrote in a report Thursday.
That’s because US junk index duration — or sensitivity to interest rates — has tumbled to an all-time low, implying a more muted impact on debt prices when the Federal Reserve eases. Less junk issuance, fewer bonds being called and a smaller concentration of high-yield bonds from better quality companies contributed to the drop in duration, according to Fridson, the chief executive officer of FridsonVision High Yield Strategy.
The strategist says the current index duration is 3.1 standard deviations below the mean for the December 1996-July 2024 period. His analysis, based on ICE BofA US High Yield Index data, shows effective duration at a record low of 3.27, from a peak of 4.77 in October 1998.
Duration — which causes bond prices to drop as rates rise, and vice versa — tumbled in the high-yield market as fewer investment-grade companies were cut to junk, creating so-called fallen angels. Borrowers with higher credit quality tend to sell bonds at longer maturities, so they typically extend junk debt index sensitivity to interest-rate moves when they are demoted.
“Measured both by number of issues and face amount, fallen angels currently account for the smallest-ever share of the ICE BofA US High Yield Index,” Fridson wrote. “The high-yield index is exceptionally short in duration and maturity at present in large part because it is less concentrated in fallen angels than it has been historically.”
This situation may not last — there’s potential for more blue-chip borrowers to lose their ratings as the US economy slows, and yields falling with rate cuts may also increase duration.
“The number of fallen angels has risen in recessions,” Fridson wrote in response to emailed questions. “All else being equal, that could push duration back up.”
He adds though, that an economic downturn may also cause high-yield risk premia to widen. That would have the counteracting effect of shortening duration, Fridson says.
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