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26 Nov 2018

US Junk Bond Yields Rising is a Huge Worry

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Rising US junk bond yields are placing pressures on high yield market globally with Eurozone junk bond yields too rising sharply.

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Arjun Parthasarathy

Rising US junk bond yields are placing pressures on high yield market globally with Eurozone junk bond yields too rising sharply. The high yield market saw a similar situation in 2016 when yields touched multi year highs but then it fell back to lows on improved economic growth outlook. Will the junk bond yields follow a similar pattern or will it continue to rise over a longer period of time?

The yields will stay under pressure as there are signs of growth slowdown, as seem by the oil price slump. This time around, Fed is on a rate hike path while ECB is unwinding stimulus and markets are not getting any liquidity injection for yields to stabilize.

Rising junk bond yields will have an effect on equity markets, as corporates may not be able to fund growth through cheap debt. Consumer lending may slow down and affect consumer sentiment. However, given that US labour markets are tight indicating a resilient economy, corporate credit health may not fall significantly and high yield markets can bounce back.

US Junk bond yields are rising sharply and have risen by over over 100bps in the last few months. Junk bond yields are rising on fall in oil prices, worries over GE debt, falling equity markets and slowdown in global growth.  Earlier, US junk bond yields were resilient to  Federal Reserve’s rate hikes and stock market turmoil, but now junk bond yields are rising as steep fall in oil prices hammered energy bonds, which account for about 15% of the high-yield index. The risk of billions of dollars of GE debt becoming junk-rated is also weighing on sentiment. Issuers of high-yield corporate bonds, or junk debt, are rated below investment-grade by credit ratings firms due to their weaker balance sheets. They typically reward investors with higher yields for taking on added risk.

US Junk Bond Yields Movement

Euro Junk Bond Yields Movement

Correction in Oil Prices- Oil prices have plunged more than $20 a barrel since the start of October 2018. In October, both OPEC and the International Energy Agency said oil consumption would grow less than previously forecast, pointing to signs of slowing global economic growth due to trade tensions, rising interest rates and weak emerging market currencies. The slump in oil prices reflects a fundamental change in the outlook for oil prices. A month ago there were concerns that a looming shortage of oil would push prices to $100 a barrel. Now, supply is expected to swamp demand at the start of 2019. 

Brent Crude Oil Price Movement

General Electric Credit Downgrade– In October S&P downgraded GE debt to BBB+, just three notches above junk rated. And in November Moodys and Fitch Ratings had also downgraded the GE debt t0 BBB+. GE has a total debt of around USD 115 Billion at the end of September 2018. GE free cash flow was negative USD 718 million in the nine months ended September 2018.

Why Credit Market is Worried– As interest rates have risen, the credit market has been getting nervous about the many large firms that have loaded up their balance sheets with debt. There is now around USD 3 trillion of borrowings rated BBB, the lowest rating bracket above junk. There are concerns that a lot of these companies might face tough times in refinancing or service their debt.

Safe Haven Demand– Risk of  global slowdown has increased  safe haven demand, as Germany & Japan economy shrank in the third quarter. In China, there are signs of a deepening economic slowdown. Germany Q3 GDP growth rate contracted by 0.2% quarter on quarter. The German economy contracted for the first time since 2015. Japan Q3 GDP growth rate contracted by 0.3% quarter on quarter basis. Chinese economy advanced 6.5% year-on-year in the September quarter of 2018, It was the lowest growth rate since the first quarter of 2009 during the global financial crisis. The International Monetary Fund  expects global growth to slow down to 2.5% in 2019 from 2.9% this year.

 

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