The junk-bond bubble bursts

Yields in the US high-yield bond market (AKA junk bonds) have soared to more than 8% since the start of the year as prices collapse.

High-yield bonds are finally living “up to their name”, says Randall Forsyth in Barron’s: yields on debt issued by companies with lower credit ratings plunged during the pandemic, as prices rose owing to ultra-low interest rates (yields move inversely to prices).

But now yields in the US high-yield market have soared by 4.2% since the start of the year to more than 8%, says Rachna Ramachandran of GMO. “There have been only two other instances in which yields have doubled so quickly” in the past 30 years: the 2008 financial crisis and the start of the pandemic in 2020.

The yield spike has brought painful losses for existing bondholders. The iShares iBoxx ETF, which tracks US investment grade debt, is down 15% this year, with a Bloomberg index of high-yield, or “junk” debt also falling 14%. Euro-denominated corporate debt is being similarly hard hit, says Sophie Rolland in Les Échos. Down 13% in the year to 20 June, the market slump far exceeds the 4% it lost in 2008, until now the worst year on record.

As well as feeling the effect of higher interest rate expectations, European debt is being hit by the European Central Bank’s (ECB) move to stop purchasing fresh debt with printed money this month. The ECB holds nearly 15% of all investment-grade euro corporate debt following previous rounds of asset purchases.  Tightening credit conditions have seen “dozens of corporate bond deals” pulled from the European market, says Ian Johnston in the Financial Times. New corporate debt issuance fell 17% in the first half compared with a year before, with European high-yield debt issuance plunging 78%.

“Bond markets have had a rough year,” says Matt Grossman in The Wall Street Journal. “Red-hot inflation makes the fixed payments offered by most debt investments less appealing.” Yet as the yields offered by corporate debt rise, investors are “giving bonds another look”. Debt issued by blue-chip firms with reliable balance sheets is appealing: “it offers higher returns than government bonds but with relatively little additional risk”.

Will defaults spread?

The key uncertainty is to what extent defaults will rise. In past downturns investors could count on central banks stepping in to ease lending conditions, says Joe Rennison in the Financial Times. Yet now, with inflation soaring, they can’t.

Credit rating agency S&P Global Ratings thinks US corporate defaults will “rise to 3% by next March, up from 1.4% the previous year”, says Julia Horowitz for CNN Business. Still, most corporate balance sheets are reasonably solid after firms “took advantage of rock-bottom borrowing costs over the past two years to stash cash and… refinance their debt”. For now, “those who trade corporate bonds aren’t overly anxious”.

Recommended

Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

Wholesale gas prices are on a downward trajectory, but does this mean lower energy bills later this year?
27 Jan 2023
Best regular savings accounts – January 2023
Savings

Best regular savings accounts – January 2023

You can earn an attractive rate on the best regular savings accounts. We tell you the best on the market to take advantage of right now
27 Jan 2023
Equity release v downsizing – which is best?
Personal finance

Equity release v downsizing – which is best?

Equity release hit a record high in 2022. But is downsizing a better way to hold on to your money?
27 Jan 2023
Self-assessment tax returns: what you need to know about getting your tax bill right
Income tax

Self-assessment tax returns: what you need to know about getting your tax bill right

Understanding how self assessment works can help you ensure you pay the right amount of tax, as well as avoid penalties for missing the deadline.
27 Jan 2023

Most Popular

Council tax increases 2023 – how much more will you pay?
Tax

Council tax increases 2023 – how much more will you pay?

Your council tax bill will go up in April - we reveal the councils that have confirmed what this year’s increase will be.
23 Jan 2023
Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

Wholesale gas prices are on a downward trajectory, but does this mean lower energy bills later this year?
27 Jan 2023
When will interest rates go up?
UK Economy

When will interest rates go up?

New interest rates will be announced on 2 February – we look at what to expect.
26 Jan 2023