The junk-bond bubble bursts

Central banks such as the US Federal Reserve cannot be relied upon to ease credit

(Image credit: © Brooks Kraft/ Getty Images)

published 20 July 2022

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.

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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”.

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”.

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.