You read that correctly. The cost for high-quality, investment grade debt has increased more than 132% in a little over three years. Meanwhile, costs to lower quality, junk rated debt have increased only 64% over the same period. If economic risks have really increased to actual depression-like conditions, we should expect to see a higher cost of borrowing for junk rated debt, alongside other, higher credit qualities. But, so far that's not happened. Though junk rated (high yield) debt/bonds offer a greater yield in nominal terms as compared to investment grade (currently around 7.8% yield on B-rated bonds), I'd expect to see these yields closer to 9%+ if there were truly concerning systemic economic issues. As it is, a mild (if any) short-term recession may be slightly priced in, based on B-rated yield levels.
More importantly, financially higher-rated companies should in theory be able to handle unexpected increases in their line-item expenses. However, rarely do CFOs witness a doubling of costs on their financing terms. That hasn't happened often over the past two decades, as the overall level of interest rates had been on an ever-declining trajectory. That was until the Fed started raising interest rates in March 2022 to combat the inflationary pressures manifested from extended periods of ultra-low interest rates.
The fixed income market is telling us that ultra-low interest on AAA rated debt was a big mistake, and it's making up for lost time. Can these quality companies handle this extreme increase in debt servicing cost without taking a hatchet to other expense line-items (e.g., payroll, leases, etc.)? My inclination is to answer in the negative, especially given the uncertainty thrust upon the global economy in the form of economic warfare (i.e., tariff negotiations).
Therefore, a natural emanation from this scenario would have an unemployment rate in the 5.0 to 5.5%, if growth drivers remain unclear for CFOs. A period of consolidation of capital would follow, where bad debts are cleared and frothy valuations come back to earth. This is a very good thing for our capitalist system. Good capital allocations are rewarded, bad ones are punished. We need a good punishing for all those bad capital allocators. "Good" vs. "Bad" requires extensive further detailed discussion. For the purposes of this research highlight, those that binged on cheap money without fueling significant growth results are deemed bad allocators.
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