Are falling real yields fuelling junk-bond binge?

Prospects of resurgence in growth after hints of vaccine progress have also bolstered demand for speculative-grade bonds

Are falling real yields fuelling junk-bond binge?

U.S. junk bonds may be looking more attractive to investors as their search for positive real yield coalesces with improving outlooks for economically sensitive companies.

Citing data from FactSet, a recent report from the Wall Street Journal noted that the real yield on a Bloomberg Barclays investment-grade corporate bond index has declined from above 0.3% at the beginning of the month to around 0.2%. And after the Federal Reserve pared interest rates to nearly zero, investors holding U.S. Treasurys are anticipated to lose money assuming they hang on to the securities until maturity.

“[Falling real yields] are pushing many investors out on the risk spectrum,” John McClain, portfolio manager at Diamond Hill Capital Management, told the Journal. “If you’re buying investment-grade bonds out to 10-years, you’re earning a potentially negative real yield.”

The results of the U.S. presidential election, coupled with reports of green shoots in the effort to produce a vaccine against COVID-19, have also firmed up demand for speculative-grade bonds. In particular, issuers in hard-hit sectors including airlines and energy companies are being assessed as likely winners in a post-pandemic economic recovery.

With that increased demand, the extra compensation investors require to hold junk bonds is being brought down. FactSet figures showed that the spread investors demand to hold speculative-grade U.S. corporate bonds in the Bloomberg Barclays index over Treasury bonds sank to 4.27%, which was within 0.2 percentage points from the November 9 close and the lowest level since late February.

In contrast, the extra yield investors demanded to hold investment-grade U.S. bonds in the Bloomberg index over Treasury bonds stood at 1.12 percentage points on Monday, also the lowest level since late February.

The junk-bond market has been on a path to recovery even prior to November’s rally, the Journal said. In spring, investors fearing a spate of bankruptcies and a protracted recession due to COVID-19 dumped lower-rated corporate bonds, causing a bloodbath in bond prices and pushing yields up past 10%, which indicates market stress.

As more money moves into companies that stand to benefit from a resurgence in growth, the high-yield market has benefited as many of the borrowers within the space operate in value sectors such as energy, financials, and industrials.

“The [corporate] constituency that makes up high-yield is very pro-cyclical, so the market is seeing some benefits from the rotation into value,” McClain said.


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