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"High Yield" or Junk Bond Yields - Why so low?
Lot of sensationalist headlines on the yield in the HY market falling below 4% , an all time low. While factual, they leave out a lot of context. Here is an attempt to explain 1/6
Lot of sensationalist headlines on the yield in the HY market falling below 4% , an all time low. While factual, they leave out a lot of context. Here is an attempt to explain 1/6
Everything in bond-land is RELATIVE to something else, i.e. available, investable alternatives. The average duration of the market is under 4 years, and yes, while there is extension risk, the average maturity is still a modest 6.5y. So what should one compare HY bonds to ?
2/6
2/6
The 5y US Treasury is the closest liquid risk free benchmark here. So how does the ratio of HY yield versus 5y Tsy look ? It is currently at nearly 9, Well above its median value of 3.5
3/6
3/6
Usually high ratios of HY to 5y Tsy don't last very long as Fed generally emabrks on a rate hiking cycle as the economy improves, or atleast market's perception of it, lifting 5y Tsy higher - this is what happened in 2016-18
Right now? Fed is on hold for a very long time
4/6
Right now? Fed is on hold for a very long time
4/6
So what can derail this ?
1. Rapid rise in 5y rates as market assumes Fed maybe forced into hikes and the forwards start to reflect this
2. Rise in HY defaults -- since the price loss is absolute and not relative. This was a "last year" problem, less so now
5/6
1. Rapid rise in 5y rates as market assumes Fed maybe forced into hikes and the forwards start to reflect this
2. Rise in HY defaults -- since the price loss is absolute and not relative. This was a "last year" problem, less so now
5/6
Ultimately HY is a risk asset like anything else and increase in equity volatility will cause spreads and yields to widen, won't be any surprise there
6/6
6/6
Also — if you look at pure spreads over risk free rates HY spread is about 327 basis pts or 3.27 percent
This number hit a low of 2.35 percent in 97 and 2.75 percent in 07. Obviously rates were higher back then
Point is what seems extreme can get more so until a catalyst hits
This number hit a low of 2.35 percent in 97 and 2.75 percent in 07. Obviously rates were higher back then
Point is what seems extreme can get more so until a catalyst hits
