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Junk yields hit 3-year low, and some investors are getting scared


Investors are getting the lowest yields on the riskiest bonds in almost three years, another sign of the high level of complacency in financial markets.

The Bank of America Merrill Lynch U.S. High Yield index is showing that so-called junk bonds are delivering yields of just 6.02 percent, down 40 percent from the more than 10 percent rate in early 2016 and at a level last seen around June 2014.

A decline in yields indicates investor demand for products at the high end of the risk scale. Demand drives prices higher and thus sends bond yields lower under the dynamics of the fixed income market. The trend comes at a time when volatility has subsided across markets, with one measure of stock market fear, the CBOE Volatility Index, hovering around historical lows.

Junk bonds and stocks often move in tandem, particularly in strong markets, and it appears again that the relentless optimism among equity investors is spreading.

“If the stock market is performing well, which it has been, high-yield also will do quite well. The correlations are much higher,” said Peter Schwab, portfolio manager at Pax High Yield Bond Fund. “A lot of these companies, while they have a lot of debt, they’re performing well.”

A look at the trajectory of junk bond yields over the past five years.

Source: FactSet

Indeed, in an era of low rates and low defaults, companies have been piling on debt.

Corporate debt currently stands at $8.52 trillion, up 57 percent from the dark days of the financial crisis in 2008, according to the Securities Industry and Financial Markets Association. Companies have been particularly aggressive in the high-yield space, with issuance year-to-date 56.6 percent ahead of the pace for the same period a year ago.

Defaults have been low, with the speculative-grade rate at 4.7 percent in the first quarter and expected to fall to 3 percent in a year, according to Moody’s ratings service.

However, investors are raising the same questions about the junk bond market as with stocks: Have things gotten too calm, and is there a storm coming?

“Given the weaker economic data, stress from retail and autos, and tight valuations, we continue to think high yield is susceptible to a backup later this summer,” Michael Contopoulos, high-yield credit strategist at Bank of America Merrill Lynch, said in a note to clients.

He’s not alone in his views.



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