This question relates to Example 2 on p.227 of Reading 11 CME Part 2. We’re given various premia and then asked to determine the effect of different events on the premia for the following year. The answer discusses how a steepening yield curve indicates an increase in both the term premium and the credit premium. The answer mentions also that a widening of credit spreads is also indicative of a higher credit premium for the following year. Then, the answer incorporates the increase in defaults on leveraged loans that has happened during the year.
“However, the increase in loan defaults suggests that credit losses are likely to be higher next year as well, since defaults tend to cluster. All else the same, this reduces the expected return on corporate bonds/loans. Hence, the credit premium should increase less than would otherwise be implied by the steeper yield curve and wider credit spreads.”
This suggests downward pressure on the credit premium. I understand that a lower credit premium means a lower expected return, but this also means upward price pressure. Why would an increase in defaults cause upward price pressure? Seems like an increase in defaults should cause downward pressure on prices, as well as a widening credit spread. Any help is greatly appreciated.