The U.S. bond market has also "caught a whiff of 2007."

Large-scale leveraged buyouts are making a comeback, risky debt is surging, and early signs of defaults among subprime consumers are emerging—key characteristics reminiscent of the U.S. bond market before the 2007 financial crisis are reappearing.

On September 28, reports indicated that from Electronic Arts Inc.'s potential $50 billion acquisition to rising auto loan default rates and the rapid expansion of the private credit market, the current financial market is showing bubble signs similar to those before the 2007 financial crisis.

Despite stricter bank regulations and more ample capital buffers, market observers are still warning about the corporate debt market. The risk premium on U.S. investment-grade corporate bonds hit a 27-year low earlier this month and is currently hovering near that level.

While analysts generally believe that the catastrophic consequences of the 2007-2009 global financial crisis will not be repeated, the historical similarities are still worth noting. As Christian Hoffmann, a 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 emerging. The U.S. unemployment rate rose to its highest level since 2021 in August, and job growth has significantly slowed. A report on Friday showed that U.S. consumer confidence fell to a four-month low in September. As the overvalued financial markets face the impact of an economic slowdown, investors may be in for a bumpy ride.

Frequent Bubble Signals

The current market is exhibiting multiple signs of bubbles, similar to those before the 2007 financial crisis.

Large-scale leveraged buyout deals are once again active, with Wall Street banks preparing to arrange over $20 billion in merger debt financing. This scene is reminiscent of 2007:

At that time, TXU Corp.'s $44 billion leveraged buyout became a landmark deal before the crisis, and now Electronic Arts Inc.'s potential $50 billion acquisition is breaking records again. Although leveraged buyout firms are currently using more equity in transactions, the expansion of deal sizes is still raising market concerns.

Rising auto loan default rates are becoming an early signal of increasing financial pressure on consumers. Subprime auto lender Tricolor Holdings suddenly filed for bankruptcy, and some asset-backed security holders were clawed back after receiving interest payments. Auto parts supplier First Brands Group LLC is also preparing to enter bankruptcy proceedings.

These signs are similar to the early stages of the subprime mortgage default wave in 2007. While overall consumer borrowing levels are lower than they were then, default signals in specific areas are still worth noting. Market participants have pointed out that while subprime mortgage consumers were defaulting on home loans back then, they are now defaulting on auto loans.

Additionally, the debt market has rapidly expanded over the past decade. The U.S. investment-grade market has grown from less than $4 trillion at the beginning of 2015 to approximately $7.6 trillion in outstanding size today. The private credit market has also relatively quickly developed into a massive market exceeding $1.7 trillion

Jia Gu Wen will issue $18 billion in investment-grade bonds this week, becoming the second-largest transaction of the year, highlighting the trend of companies borrowing heavily for AI investments.

Private credit-backed bonds have become Wall Street's hottest financial product, with heavyweight firms like Blackstone, Apollo Global Management, and Golub Capital issuing such products at a record pace.

Hunter Hayes, Chief Investment Officer of Intrepid Capital Management, stated, "Every day I see things that make me think 'this is very bubbly,' but it's hard to know how much contagion these obviously bubbly headline events will generate."

Wall Street Titans Warn of Corporate Bond Market

The risk premium on U.S. investment-grade corporate bonds has reached its lowest level in 27 years, reflecting an overly optimistic pricing of risk in the market.

Several market observers have expressed concerns about the current valuation levels:

JP Morgan CEO Jamie Dimon stated in June that if he were a fund manager, he would not buy credit products.

DoubleLine Capital CEO Jeffrey Gundlach indicated that the firm has been reducing its exposure to junk bonds because valuations have failed to reflect risk.

Sixth Street Partners co-founder and co-CIO Josh Easterly pointed out significant risks in the market in May.

Brandywine Global Investment Management portfolio manager Bill Zox remarked, "At such high valuation levels, it doesn't take much to bring panic back to the market."

No Global Financial Crisis 2.0, But...

Despite the similarities, the current market environment has important differences from 2007.

Bank regulations are stricter, with larger capital buffers. Consumer borrowing is relatively small. Leveraged buyout firms are using more equity funding in acquisitions. It remains unclear whether private credit will cause widespread losses in the financial markets.

Christian Hoffmann, portfolio manager at Thornburg Investment Management, stated, "Every cycle is unique, and every crisis is special."

However, he added: "When you price things to perfection, any imperfection can lead to at least one adjustment."

This means that investors may face a bumpy road ahead, as a bubbly financial market needs to adjust to a cyclical slowdown. Even if a Global Financial Crisis 2.0 does not erupt, a significant adjustment in assets is still likely to occur.

In addition to the bond market signaling early signs of a bubble, the U.S. economy is showing early signs of weakness.

The latest U.S. non-farm payroll report shows that the unemployment rate rose to its highest level since 2021 in August, with employment growth significantly slowing. A 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 realistic basis for concerns in the bond market, although these troubling signals are still in the early stages. Analysts point out that investors may face a bumpy road ahead as the inflated financial markets need to adjust to the cyclical economic slowdown.