The U.S. bond market is exhibiting characteristics reminiscent of the period before the 2007 financial crisis: a surge in leveraged buyouts, record-low risk premiums for investment-grade bonds at their lowest in 27 years, rising auto loan default rates, and private credit expanding to $1.7 trillion. While most analysts do not believe a similar crisis will unfold, the historical parallels are concerning—when assets are priced to perfection, any flaw can trigger a correction.
The resurgence of large-scale leveraged buyouts, a surge in risk debt, and early signs of subprime consumer defaults indicate that the U.S. bond market is exhibiting key characteristics reminiscent of the period prior to the 2007 financial crisis.
On September 28, reports indicated that from the potential $50 billion acquisition of Electronic Arts Inc. to rising auto loan default rates and the rapid expansion of private credit markets, current financial markets are showing bubble-like symptoms similar to those observed before the 2007 financial crisis.
Despite stricter bank regulations and more robust capital buffers, market observers are issuing warnings about the corporate debt market. The risk premium for U.S. investment-grade corporate bonds touched its lowest level in 27 years earlier this month and remains near that level.
Although analysts generally believe that the catastrophic consequences of the 2007-2009 global financial crisis will not be repeated, the historical parallels remain a cause for caution. As Christian Hoffmann, portfolio manager at Thornburg Investment Management, stated:
"When you price assets to perfection, any imperfection can trigger a correction."
Notably, early signs of an economic slowdown are beginning to emerge. The U.S. unemployment rate in August rose to its highest level since 2021, with employment growth significantly slowing. A Friday report showed that U.S. consumer confidence dropped to a four-month low in September. As highly valued financial markets face the impact of an economic slowdown, investors may encounter volatile conditions.
Frequent signs of bubbles
The current market is showing multiple signs of bubbles, similar to those observed before the 2007 financial crisis.
Large-scale leveraged buyout deals are once again becoming active, with Wall Street banks preparing to arrange more than $20 billion in M&A debt financing. This mirrors what happened in 2007:
The $44 billion leveraged buyout of TXU Corp. was a landmark deal before the crisis, and now Electronic Arts Inc.'s potential $500 billion acquisition is setting a new record. Despite leveraged buyout firms using more equity in transactions, the expansion in deal sizes continues to raise market concerns.
Rising auto loan default rates are emerging as an early signal of increasing financial pressure on consumers. Subprime auto lender Tricolor Holdings abruptly filed for bankruptcy, and some asset-backed securities holders had funds reclaimed after receiving interest payments. Auto parts supplier First Brands Group LLC is also preparing to enter bankruptcy proceedings.
These signs resemble the early stages of the subprime mortgage default wave in 2007. Although overall consumer borrowing levels are lower than at that time, default signals in specific sectors remain noteworthy. Some market participants noted that subprime borrowers who once defaulted on mortgages are now experiencing auto loan delinquencies.
Furthermore, the debt market has expanded rapidly over the past decade. The U.S. investment-grade market grew from less than $4 trillion in early 2015 to approximately $7.6 trillion currently. The private credit market has also developed relatively quickly, becoming a massive market exceeding $1.7 trillion.
Oracle’s issuance of $18 billion in investment-grade bonds this week became the second-largest deal of the year, highlighting the trend of companies borrowing heavily to fund AI investments.
Bonds backed by private credit have become one of Wall Street's hottest financial products, with heavyweight firms such as Blackstone, Apollo Global Management, and Golub Capital issuing them at record speeds.
Hunter Hayes, Chief Investment Officer of Intrepid Capital Management, stated: "Every day I see something that makes me think, 'This is very bubble-like,' but it's hard to know how much contagion these obviously bubble-like headlines will generate."
Wall Street Titans Warn of Corporate Bond Market Risks
The risk premium for U.S. investment-grade corporate bonds has reached its lowest level in 27 years, reflecting overly optimistic market pricing of risks.
Several market observers expressed concerns about current valuation levels:
JPMorgan CEO Jamie Dimon stated in June that if he were a fund manager, he would not purchase credit products.
Jeffrey Gundlach, CEO of DoubleLine Capital, said the company has been reducing its exposure to junk bonds as valuations fail to reflect risks.
Josh Easterly, co-founder and co-chief investment officer of Sixth Street Partners, highlighted significant risks in the market in May.
Bill Zox, portfolio manager at Brandywine Global Investment Management, said: "At such high valuation levels, it doesn't take much to bring panic back to the market."
There will be no Global Financial Crisis 2.0, but...
Despite some similarities, there are important differences between the current market environment and that of 2007.
Bank regulations are stricter, with larger equity buffers. Consumer borrowing remains relatively low. Leveraged buyout firms use more equity funding in acquisitions. It is unclear whether private credit will cause widespread losses in financial markets.
Christian Hoffmann, portfolio manager at Thornburg Investment Management, said: "Each cycle is unique, and every crisis is special."
However, he added: "When you price things to perfection, any imperfection can lead to at least a correction."
This means investors may face a bumpy road ahead as bubble-like financial markets adjust to cyclical slowdowns. Even if there is no Global Financial Crisis 2.0, significant asset adjustments remain possible.
In addition to the early signs of a bubble in the bond market, the U.S. economy is showing initial signals of weakness.
The latest U.S. nonfarm payroll report shows that the unemployment rate rose to its highest level since 2021 in August, with significant slowing in job growth. The report released on Friday indicated that the U.S. consumer confidence index fell to a four-month low in September.
The deterioration of these economic indicators provides a real basis for concerns in the bond market, although these challenging signs remain in their early stages. Analysts noted that investors may face a bumpy road ahead as the frothy financial markets need to adjust to the cyclical slowdown of the economy.
Editor/Melody