Treasury Today Country Profiles in association with Citi

Junk bond investors go cold turkey

The prospect of lower-than-expected growth in the US has fed into an already jittery investment environment and caused junk-rated debt issuance to sieze up.

Spreads on non-investment grade debt over Treasuries have risen sharply over the past few months – from 5.58% in mid-July to 7.43% in late August, Bank of America Merrill Lynch index data show.

This has been provoked in part by sizeable outflows among mutual funds investors, with the funds having to sell off junk debt as a result. The spike in yields was reflected in the precipitous downturn in junk debt issuance; a negligible $1.2 billion (the lowest since December 2008) was raised over the month, 93% down on July’s figure of $18.2 billion.

Optimists remain hopeful that a fresh round of Federal Reserve asset buying (QE3) will provide the fillip the markets need. However, even if the Fed does decide to purchase Treasuries, it is unlikely to stave off recession. All of which means that storm clouds will continue to gather on the debt market’s horizon.

So while there is some chance that demand for junk bonds will return in September, that won’t distract investors from the fact that doubts remain in the US over the prospect of job growth and that Europe’s sovereign-debt worries are far from over.

Add to this that debt market investors are more cautious than their equity investor counterparts (because of their focus on downside risk) and markets are expected to remain moribund for some time, says William Larkin, a fixed-income money manager at Massachusetts-based Cabot Money Management.

“Yields are so expensive that a lot of people are in a wait-and-see mode. There’s a lot of concern over what the Fed may do. Right now, cash is probably not a bad investment to hold.”