Credit Skeptics Place a $10 Billion Bet in High-Priced Market
(Bloomberg) -- A small band of Wall Street skeptics are moving to protect their credit portfolios against a market priced like nothing in the economy could possibly go wrong.
Investors have placed $10 billion of bets that high-yield corporate bond exchange-traded funds will drop, the most since at least 2023, running counter to a New Year rally that’s swept through global markets. JPMorgan Chase & Co. derivatives strategists are warning that risk premiums are approaching levels that are no longer equal to the unpredictable economic and political climate.
“You want to take a step back from the market as a whole and buy protection here,” said Alberto Gallo, chief investment officer at Andromeda Capital Management in London. “Credit investors have never been so complacent.”
With the premiums that investors get for lending to Corporate America vanishing, a handful of investors including Gregory Peters of PGIM Fixed Income, which manages about $850 billion, is touting Treasuries over company debt.
Their caution makes them outliers in markets riding high on prospects for the American economy in the next four years. Notwithstanding this week’s wobble as broader markets sold off along with AI-exposed stocks, spreads on corporate debt have rarely been so low.
Like the rest of Wall Street, corporate bond investors are lining up behind President Donald Trump, the self-styled ‘King of Debt,’ enamored by his business-friendly agenda and implicit promise to keep propelling markets higher. Rolling back from his campaign promise to immediately slap tariffs on the largest US trading partners, Trump added to the ebullient mood in markets over his first week, but fresh provocations have left doubts about the global trade outlook down the road.
“We’ve only just started 2025 and it appears that credit markets are close to if not already in overbought territory,” JPMorgan credit derivative strategists including Saul Doctor wrote in a Jan. 24 note. “It seems prudent to start hedging given where spreads currently stand and the geopolitical uncertainty we face under the new administration.”
Even the most hyped assets are vulnerable to sharp setbacks — as the arrival of an artificial intelligence model from Chinese startup DeepSeek this week showed. DeepSeek’s model roiled not just US rivals but weighed across risk markets, causing broad-based spread widening in both junk and investment grade credit.
Higher yields overall are luring investors even as spreads remain close to the tightest they have been this century. As a result, the asset class looks less appealing next to government bonds with 30-year Treasuries yielding close to 5%.
“All else equal, I’d rather have duration risk in my portfolio,” Peters, co-chief investment officer at PGIM Fixed Income, said in an interview with Bloomberg TV on Jan. 15. “It provides that ballast if things go pear-shaped economically.”
For companies carrying big debt loads, and their lenders, the risk is that inflationary fiscal policies curbs the Federal Reserve’s ability to lower interest rates this year. That would leave firms big and smaller with high refinancing costs for longer than they anticipated.
The risks aren’t reflected in junk bond spreads — the yield these bonds offer above government debt — at pre-financial crisis levels, or those for investment-grade corporate debt at a three-year low. Rampant demand for new issues is allowing the most indebted companies to keep refinancing.
Part of the reason investors are willing to accept razor-thin margins on corporate credit is that over time, the ratings mix of borrowers has shifted to higher-quality assets overall, according to BlackRock Inc.’s co-head of leverage finance Mitchell Garfin. Still, he says it’s unlikely spreads will tighten by much more.
“We’re constructive on the high-yield asset class, but we’re also very cognizant of where spreads and valuations are today,” Garfin said.
Investment-grade companies have become more leveraged in the past three years, carrying debt of more than three times their cash flow, according to research from Schroders. By contrast, the trend for speculative-grade borrowers has been broadly stable at around four times, and remains below the two-decade peak of 5.5 times it hit in the pandemic.
“The key issue is if the Fed keeps interest rates at these levels, you’re increasingly running the risk that these companies which have coupons of 4.5% to 5% are suddenly forced to refinance into 8.5%,” said Michael Green, chief strategist at Simplify Asset Management. “That meaningfully impacts their ability to repay their debt.”
Some are turning to ETFs to set up bets that pay off when spreads widen on the perceived risk of a wave of corporate bond defaults.
Short interest on the $15 billion iShares iBoxx High Yield Corporate Bond ETF has swelled to about 50% of shares outstanding, according to data from analytics firm S3 Partners — the highest level since 2023. A similar trend can be seen in two of the other largest US junk bond ETFs, with all three amounting to almost $10 billion of hedges against corporate failures.
“The market is priced for perfection, and either a growth bump or more likely a re-acceleration in inflation can trigger a spread widening,” said Gallo at Andromeda Capital.