The Fed is powerless to stop the market's riskiest debt from getting downgraded and defaulting, Goldman says
- Junk bonds still face "numerous fundamental headwinds" despite unprecedented aid from the Federal Reserve, Goldman Sachs said Thursday.
- Spreads for high-yield debt will increase through the second quarter and remain elevated from current levels until the end of the year, Lotfi Karoui, chief credit strategist at Goldman, wrote in a note.
- The bank's baseline scenario sees the 12-month trailing default rate jumping to 13% through 2020.
- More than half a trillion dollars in investment-grade bonds will slide into junk status within the next six months, Goldman added.
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Credit markets breathed a sigh of relief after the Federal Reserve stepped in with critical aid, but US junk debt isn't in the clear just yet, Goldman Sachs said Wednesday.
While investment-grade debt likely saw its trough in late March, the market's riskiest bonds will still contend with "numerous fundamental headwinds" in the near future, Lotfi Karoui, chief credit strategist at Goldman, wrote in a note to clients. Junk bonds' spreads - their yields compared to US Treasury notes - will soar through the first half of 2020 and remain elevated from current levels until the fourth quarter, he added.
After weeks of intense stock market declines, corporate credit took the stage as the next asset to face major coronavirus risks. Sudden business closures and work-from-home mandates forced firms to rush for cash stockpiles. The moves spiked the cost of cash and drove widespread downgrades as ratings agencies feared for the worst.
"Despite the strength of policy support, the cyclical challenges for corporate borrowers remain substantial," the strategist said. "As has been the case in past downturns, financial distress will continue to increase, leading to higher defaults and downgrades."
The firm's baseline scenario for high-yield debt sees the 12-month trailing default rate soaring to 13% in 2020. The next six months will push $555 billion worth of investment-grade bonds into junk status as cash flows dry up and earnings growth lags, according to Karoui. Roughly $149 billion in investment-grade bonds have already been downgraded to high-yield status in 2020.
The Fed's new lending pools for struggling businesses may not keep junk bonds from falling further, but several firms see the stimulus as a promising investment opportunity. Bank of America analysts advised clients on Friday to buy what the Fed buys after March's "Fast and Furious" sell-offs.
Emerging-markets debt and high-quality corporate credit are "much safer to own" after the central bank's policy announcement, strategists at UBS said Tuesday.
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