Junk Bond Yields Plunge As Investors Go All In On Risk

Posted by on February 9, 2017 2:27 pm
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I have a feeling that these risky bets will soon turn to crocodile tears.

Financial Times Writes:

Investors pile into risky bonds in bet on Trump economy

Investors are piling into some of the riskiest bonds sold by US companies as they bet on President Donald Trump delivering on his promises of a stronger economy, lower taxes and less regulation.

Demand for junk-rated bonds has driven yields on debt with the lowest quality credit rating down towards 10 per cent as more than $10bn has flowed into funds that invest in the asset class since the start of December.

Borrowings by triple-C rated groups, among the lowest tier of the high-yield universe, have risen nearly two-thirds from a year earlier when the average yield for this part of the junk market peaked at 21.7 per cent. Yields fall as bond prices rise.

The current market rally has allowed the extension of credit to riskier borrowers at appealing terms, with high-yield groups raising a total of $41bn in the US so far this year, including money to refinance older debt — the greatest amount for a comparable period since 2013, according to Dealogic.

“People are more comfortable taking risk, driven by optimism around new policies and the risk-on mentality,” said Raman Srivastava, deputy chief investment officer of Standish Mellon Asset Management.

Bullish investor sentiment, however, comes as warnings mount over the outlook for the $2.2tn US junk bond market, led by a looming $1tn “maturity wall” facing lower rated companies over the next five years, a record level according to rating agency Moody’s.

The maturities peak in 2021, when more than $400bn of bonds and bank loans come due. At the same time, analysts with the credit agency warn that ratings on the loans have “deteriorated significantly”.

“It is becoming impossible to ignore downside fundamental and political risks,” said Stephen Caprio, a strategist with UBS.

“Bank and nonbank lending standards are not easing, credit card and auto loan delinquencies are rising, bank commercial and industrial loan growth has stalled, and more protectionist sentiment is being underpriced in our view as a macro risk.”

The so-called Trumpflation Trade has driven investors into the asset class and pushed the risk premium they demand to own the bonds back down to levels last seen in 2014.

Lower corporate taxes would free cash up for interest payments by these companies, while a reduced regulatory burden could bolster margins, investors and strategists say. Faster economic growth would in turn underpin higher sales.

The recent tempering of inflation expectations — in part due to weaker than expected US wage gains in January — has added to credit’s allure, as yields on the securities look more attractive than haven assets.

Risk premiums on high yield and investment grade corporate debt — a measure of the spread investors demand to hold those bonds over benchmark US Treasuries — have fallen to within 259 basis points of each other, Bank of America data show.

That is down from a peak of over 650bp a year ago, when a rapid decline in commodity prices and fears of a Chinese slowdown sparked broader market turmoil.

“There was a lot of fear and loathing in the market last year,” said Mary Bowers, a portfolio manager with HSBC. “That has fallen into the background with the strength of the equity market since Trump was elected.”

That is to say, everyone and their day trading grandmother have pilled into the same trade. The Trumpflation trade. May it be in the stock market, currencies, interest rates or junk bonds. The problem is, we all know what happens when everyone agrees on somethings.

If you would like to find out exactly what happens next based on our Timing and Mathematical work, please Click Here.