Riskiest U.S. Junk Bonds Exit Distress, Back to Pre-Covid Levels

(Bloomberg) -- The lowest-rated U.S. junk bonds left distressed territory for the first time since the pandemic after spreads on the securities fell beneath 1,000 basis points on Aug. 3

The average spread over Treasuries for bonds in the Bloomberg Barclays CCC index tightened 16 basis points to 996 basis points, the lowest since Feb. 27. That marks an exit from a level typically associated with distress.

The index move underlines a recovery for junk bonds that coincides with a broader rally in the credit market following unprecedented support from the Federal Reserve. Some strategists say improvements among CCC rated bonds represent a potential signal that the credit cycle has turned a corner and put much of the chaos generated by the pandemic in the rear view mirror, at least for now.

John McClain, a portfolio manager at Diamond Hill Capital Management, said there were still reasons to be cautious. Part of the recovery in spreads reflects the removal of debt from the index of companies that have already defaulted, and the tightening could serve as a “value trap” by luring unwary investors who still need to differentiate between credits, he said.

“We would caution investors from dipping into this part of the market aggressively,” McClain said in an interview.

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