Junk bond spreads surge as investors consider virus risks
The premium that investors demand for owning risky high-yield debt has surged by more than at any time since the Brexit vote in 2016, as the coronavirus outbreak has menaced corporate credit markets this week.
The extra yield on US junk bonds versus Treasuries, known as the spread, jumped 52 basis points from 366bp on Friday to 418bp on Tuesday, the biggest two-day rise since the UK voted to leave the EU nearly four years ago, according to a closely followed index from Ice Data Services.
A junk bond sell-off has unfolded alongside a sharp drop in global equity markets, reacting to the spread of the coronavirus beyond its epicentre in Wuhan, China.
“The market has been slapped hard,” said Ken Monaghan, co-director of high yield at Amundi Pioneer in Durham, North Carolina.
Companies have held off tapping the corporate bond markets — critical financing sources — this week amid uncertainty over the scale of the economic impact, according to bond portfolio managers. There has been no issuance either of junk bonds or investment-grade debt.
“They don’t want to come to market in these kinds of conditions,” said Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors. “They come to market only when the bargaining power is decidedly in their favour.”
Jeffrey Gundlach, chief executive of DoubleLine Capital, told the Financial Times that the $1.2tn high-yield bond market, where prices dropped below their 200-day moving average, a key technical level, is “the canary in the coal mine” signalling more market turmoil ahead.
Mr Gundlach noted that the Dow Jones Industrial Average of blue-chip equities also dropped below its 200-day average on Tuesday, “foreshadowed” by the downdraft in junk bonds.
The selling in junk bonds is closely monitored by investors and traders because companies with the lowest bond ratings are typically the most vulnerable to the effects of an economic downturn.
The sell-off on Tuesday was broad based, although energy company debt continued to lead the decline because the oil price was once again lower. Junk bonds issued by household goods retailer Bed Bath & Beyond, steel producer US Steel and Kool-Aid maker Kraft Heinz all fell on Tuesday, according to bond trading platform MarketAxess.
Higher-rated corporate debt was also hit, with bonds from carmaker Ford, drugmaker Mylan and cable television operator ViacomCBS all sliding in value.
Fears of an economic slowdown and the deepening sell-off in stock and corporate credit markets have prompted traders to look to the Federal Reserve for looser monetary policy. Traders have raised the odds of a quarter-point reduction in the US central bank’s main policy rate at its June meeting, according to data compiled by the CME Group.
The Fed would be forced to cut rates sooner rather than later, in response to slower economic growth stemming from the spread of the coronavirus, Mr Gundlach said.
“The Fed is in a world of hurt, again. Just a few weeks ago they were acting all self-congratulatory that their policy was ‘in a good place’. Now they may need to do a huge pivot, again.”
Additional reporting by Joe Rennison