January 14, 2013 7:19 pm

Junk bond prices point to return of bulls

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The junk bond market is sending a bullish signal for the global economy in 2013, with investors in US high-yield securities earning higher returns so far this year than those who have bought investment-grade debt.

High-yield bonds are an acute barometer of risk appetite and rises in their prices have often signalled a turn in sentiment. With yields for US junk bonds below 6 per cent, investors are indicating they believe the global economy is on firmer footing and the risk of a financial crisis is diminishing.

However, the appeal of junk bonds also has been boosted – unduly, in the eyes of some – by the overall low level of interest rates. Yield-hungry investors have few alternatives, and inflows into junk bond funds last week reached their highest levels since mid-September, according to EPFR.

“High-yield has a captive audience,” said Adrian Miller, director of fixed-income strategy at GMP Securities. “There’s a universe of investors sitting on piles of excess cash that needs to go somewhere. It is all going to high-yield.”

The strong start to the year, however, faces headwinds in Washington, where President Barack Obama on Monday called on Republicans in the US Congress to lift the country’s borrowing limits without preconditions.

Mr Obama warned that markets could go “haywire” if there is another confrontation over the US debt limit. “Interest rates could spike for anyone who borrows money, he said. “It would be a self-inflicted wound for our economy.”

But Jody Lurie, a corporate credit analyst at Janney Capital Markets, said: “With debt ceiling discussions still a few weeks away, investors are taking this window of opportunity to load up on higher yielding assets.”

So far this month, investors are sitting on a total return – income, plus price gains – of 1.3 per cent from US-dollar junk bonds, according to Barclays indices. By contrast, investment grade bonds have returned a negative 0.15 per cent.

The biggest gains in the junk bond market have been registered in its lowest-rated corner – triple-C debt, which yields an average of 8.2 per cent, down from 11.5 per cent in one year. Investors in these bonds have earned a total return of nearly 2 per cent this year.

“The performance differential between junk and investment grade debt is quite striking so early in the year,” said Edward Marrinan, head of macro credit strategy at RBS Securities.

European high-yield debt has also outperformed higher quality corporate debt, with a rise of 1.7 per cent this month.

The total return for US junk bonds was 15 per cent last year, spurring such large bond managers as Pimco and BlackRock to warn that investors were not being properly compensated for the risks they were taking.

Following this month’s gains, analysts are also warning investors to be careful about their total return exepctations. Mr Miller said investors should expect “modest” returns on high-yield in 2013 of about 6.5 per cent.

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