A Growing Number of Bonds Edge Closer to Junk Status

On the surface, the US corporate bond market appears calm and well supported. Issuance is strong, investor demand remains healthy, and borrowing costs are relatively contained. Yet beneath that stability, there are emerging warning signs tied to companies that sit uncomfortably close to losing their investment-grade credit ratings.

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The first full week of the year marked one of the most active periods for US corporate bond issuance on record. Companies rushed to tap debt markets early, taking advantage of steady demand and favorable pricing conditions. Despite the surge in supply, credit spreads remained tight, signaling that investors are still willing to accept relatively low compensation for taking on corporate risk.

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This confidence, however, may be masking a growing vulnerability. According to data from JPMorgan Chase & Co., the volume of bonds hovering just above junk status climbed sharply last year. These so-called “fallen angel candidates” — issuers rated at the lowest rung of investment grade — now represent a larger share of the market than in recent years, raising concerns about how resilient the credit landscape really is.

Investment-grade bonds are typically viewed as safer holdings, especially for institutional investors such as pension funds, insurers, and conservative asset managers. But when companies sit one downgrade away from high-yield status, even modest changes in economic conditions can trigger forced selling. A downgrade can push bonds out of investment-grade indices, prompting large-scale reallocations that amplify market stress.

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The current environment has allowed weaker issuers to borrow on surprisingly favorable terms. Strong demand for yield, combined with expectations that interest rates may stabilize later in the year, has encouraged investors to look past deteriorating balance sheets. As a result, companies with elevated leverage or declining cash flow have still been able to issue debt without paying a significant premium.

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This dynamic has been particularly visible in sectors facing structural challenges. Industries such as telecommunications, media, retail, and certain areas of healthcare account for a sizable portion of the bonds clustered near the investment-grade cutoff. These companies often carry high debt loads and face competitive or regulatory pressures that could worsen if economic growth slows.

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Another factor contributing to the rise in downgrade risk is the cumulative effect of higher interest rates over the past few years. Many companies refinanced debt at higher costs, increasing interest expenses and squeezing coverage ratios. While revenues have held up so far, any slowdown in earnings could quickly strain balance sheets, making ratings agencies more cautious.

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Despite these risks, market pricing suggests little immediate concern. Credit spreads remain compressed, and volatility has been limited even during periods of heavy issuance. For now, investors appear comfortable betting that economic growth will remain strong enough to prevent a wave of downgrades. That optimism has helped keep funding conditions loose for borderline issuers.

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Still, history shows that calm conditions can change quickly. When downgrades accelerate, liquidity in affected bonds often dries up, pushing prices lower and yields sharply higher. The transition from investment grade to junk can be abrupt, leaving investors with fewer exit options. This risk is especially pronounced when many issuers are downgraded at the same time.

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Portfolio managers are increasingly aware of this imbalance. Some have begun trimming exposure to bonds rated BBB, the lowest investment-grade category, in favor of higher-quality credits or selective high-yield names where compensation for risk is clearer. Others are relying more heavily on credit-default swaps and other hedging tools to manage downgrade exposure.

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For companies on the edge, maintaining their ratings has become a strategic priority. Management teams are emphasizing cost controls, asset sales, and disciplined capital spending to reassure both investors and ratings agencies. In some cases, firms have delayed share buybacks or dividend increases to preserve cash and protect their credit profiles.

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Looking ahead, the trajectory of the economy will be critical. If growth remains resilient and financing conditions stay supportive, many of these borderline issuers may avoid downgrades altogether. However, a slowdown in consumer spending, a rise in defaults, or renewed inflation pressure could quickly test the market’s confidence.

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For investors, the message is clear: while the US corporate bond market currently looks healthy, underlying risks are building. Tight spreads and heavy issuance may be obscuring vulnerabilities that only become visible during periods of stress. As the year unfolds, careful credit selection and active risk management will be essential, particularly for those exposed to bonds sitting just one step above junk status.

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