Investors are piling into some of the riskiest bonds sold by companies as they bet on Donald Trump delivering on his promise 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 $10 billion (€9.4 billion) 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 bonds, 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 $41 billion in the US so far this year, including money to refinance older debt – the greatest amount in the same 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 $2.2 trillion US junk bond market, led by a looming $1 trillion “maturity wall” facing lower-rated companies over the next five years, a record level according to rating agency Moody’s.
Ratings deterioration
The maturities peak in 2021, when more than $400 billion of bonds and loans come due. At the same time, analysts at the credit agency warn 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."
But lower corporate taxes promised by the new president would free up cash for interest payments by junk-rated companies, while a reduced regulatory burden could bolster margins, investors and strategists say.
Risk premiums on high-yield and investment grade corporate debt – a measure of the spread investors demand to hold those bonds over haven US treasuries – have fallen to within 259 basis points (bps) of each other, Bank of America data shows.
That is down from a peak of more than 650 bps a year ago, when a rapid fall 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 since Trump was elected." – (Copyright The Financial Times Limited 2017)
