Here's a potential road map for what could happen to riskier corporate bonds if inflation hits 10%, according to BofA Global strategists.
What happens to companies financed in the booming high-yield or “junk-bond” market on the off chance that U.S. inflation pegged at 7.9% in February soars to 10% and stays there?
That’s a question Oleg Melentyev’s credit team at BofA Global explored in a client note Friday, with a look at past instances when American inflation climbed that high, and stuck around for a while. “The troughs in earnings growth were in the -20% context in 1976 and 1983, i.e. in the aftermath of recessions,” Melentyev’s team wrote.
Still, Melentyev’s team thinks defaults in the event of a recession could stay low because issuers can repay old debts with inflated cash flows. Junk-bond spreads, or the premium paid above the risk-free Treasury rate, fell to about 343 basis points above the Treasury TMUBMUSD10Y rate on Thursday, down from around 421 basis points roughly two weeks ago, according to the ICE BofA US High Yield Index.
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