Junk Bond Yields Go Negative As Central Banks Cut Interest Rates And Print Money (#GotBitcoin?)
Oxymoron Alert: Some ‘High Yield’ Bonds Go Negative. Junk Bond Yields Go Negative As Central Banks Cut Interest Rates And Print Money (#GotBitcoin?)
Many expect more bond yields to go negative as central banks in the U.S. and Europe cut interest rates or return to bond buying to stimulate economies.
For junk bonds that have negative yields, peculiar characteristics help explain their especially ultralow rates.
In the latest sign of financial markets going into uncharted territory, more than a dozen junk bonds, which usually carry high yields, now trade in Europe with a negative yield.
It is a stark illustration of how ultra-loose monetary policies have turned debt investing into a choice about how to lose the least amount of money.
European investors have gotten used to paying for the privilege of owning safe government bonds with negative yields, a kind of backward interest rate that shows the rate at which your money will shrink over time. Investors have also gotten used to highly rated, investment-grade companies trading with negative yields.
But junk bonds are typically risky borrowers with weaker balance sheets and often smaller businesses that may struggle to pay back what they borrow anyway.
“It is a perverse situation,” said Colin Purdie, chief investment officer for credit at Aviva Investors. “It is called ‘high yield,’ so to get a negative yield is pretty unusual. But it’s not completely crazy. For some investors, there is an acceptance that it’s not about absolute returns, but relative returns.”
There are about 14 companies with junk bonds worth more than €3 billion ($3.38 billion) that are trading with negative yields, according to Bank of America Merrill Lynch. They include telecom giant Altice Europe NV and tech-equipment company Nokia Corp.
The Bank of America analysts, who monitor all major corporate bonds in Europe, say they hadn’t seen any negative-yielding junk bonds until recently.
Pushing yields to record lows: The European Central Bank has hinted it will cut its already-negative policy rate in coming months or unveil a restart to its bond-buying stimulus program. Meanwhile, a shortage of high-quality government and corporate bonds has led investors to buy riskier debt to find some income.
To be sure, most junk bonds are still solidly in positive-yielding territory. The yield for BB-rated bonds, the top end of junk, in the ICE Bank of America Merrill Lynch euro high-yield index is 1.9%—down from 3.6% in January—while the average for all junk-rated debt in the index is 3%, down from 4.9%.
And the junk bonds that have negative yields sport peculiar characteristics that help explain their especially ultralow rates.
About half of the negatively-yielding junk bonds have a chance of being repaid early. For some of these, investors buying them now are paying more than their repayment value if they get called, so they would definitely lose money. For example, Mary Pollock, telecoms analyst at CreditSights, points to Altice Luxembourg’s 2022 bonds, which are currently callable, but trade at a price above the call price. They have a yield to call of minus 7.65%, but a yield to maturity of 6.04% (positive), according to FactSet data. Investors may be betting the company doesn’t redeem the bonds.
Others have definite near-term repayment dates, but are improving companies and nothing is likely to go wrong before the bonds are paid back. Investors buying such bonds will lose less than if they put their money on deposit, for example.
One euro junk bond from U.S. packaging company Ball Corp , for example, trades at a yield of minus 0.2% and matures in December 2020. That compares to a European deposit rate of minus 0.4%, or a yield on a German government bond with a similar maturity of about minus 0.7%.
The choice for investors is about the balance between needing to stay invested and how much risk to take, according to Tim Winstone, a fixed-income portfolio manager at Janus Henderson.
A bond like Ball Corp’s is “a safe place to hang out,” Mr. Winstone said. “And just because something is negative yielding, that doesn’t mean it can’t get more negative yielding.” Falling yields mean rising bond prices and gains for investors, at least on paper.
In Europe especially, investors are realizing that negative interest rates are going to last a long time because the ECB needs to overshoot its inflation target to make up for the long spell when inflation has been far below 2%. Without a period of higher inflation, it won’t meet its target on average over the medium term.
The number of junk-rated companies with negative-yielding bonds will definitely go up, according to Barnaby Martin, credit strategist at Bank of America Merrill Lynch. “It doesn’t take much for it to go from 14 companies to 30 or 50 or 100,” he said.
At the moment, about 2% of the European high-yield market has negative yields and Mr. Martin said that if there was just a 0.4 percentage-point reduction in average spreads—or the extra yield that junk bonds pay over safe government debt—then about 10% of the market would be at negative yields.
High demand for European investment-grade bonds from Japanese and U.S. investors is another factor pushing yields down across the markets. That is also pushing European investors from investment-grade debt and further into high yield.
“Investment grade is nuts,” says Mr. Winstone. “About 24% of my benchmark yields less than zero.”
The next step in junk bonds could be even more surprising. “I expect to have a high-yield company issue a negative-yielding bond,” said Martin Reeves, head of high yield at Legal & General Investment Management.
“Many investors need a positive income solution and that will force them into high yield and so lead to yields compressing.” Junk Bond Yields Go,Junk Bond Yields Go,Junk Bond Yields Go
Global Easing Cycle Gains Momentum As Central Banks Cut Rates
With Fed and ECB expected to cut rates soon, central banks in South Korea, Indonesia and South Africa move first.
Central banks in Asia and South Africa lowered their interest rates Thursday, joining a global easing bandwagon that started earlier this year in the Asia-Pacific region and is expected to include the U.S. and Europe within weeks.
The latest moves, by central banks in South Korea, Indonesia and South Africa, underscore the global nature of the brewing rate-cutting cycle, as policy makers attempt to ward off signs of weaker economic growth. With economies and financial markets interconnected, expectations of lower interest rates by the Federal Reserve and European Central Bank have given central banks in emerging markets scope to lower rates and prop up their economies.
“I think this will provide further impetus for Asian central banks in their easing cycle ahead,” said Prakash Sakpal, an economist at ING Bank.
Since April, New Zealand, India, Malaysia and the Philippines have lowered rates. China’s central bank has taken a number of measures to encourage lending to small businesses, and investors expect it to reduce benchmark rates if the Fed lowers its rates.
Three central banks lowered rates Thursday, joining a cycle started by several Asia-Pacific central banksearlier in the year.
The Bank of Korea unexpectedly lowered interest rates for the first time in three years Thursday, responding to pressure to ease policy as economic growth slows. It lowered the base rate by a quarter percentage point to 1.5%.
The move took analysts by surprise. Of the 19 analysts polled by The Wall Street Journal ahead of the decision, 12 had forecast the central bank would stand pat this month and cut the rate in August.
The central bank signaled more rate cuts may be coming, downgrading its growth and inflation forecasts for 2019.
The downgrades suggest “that the cut was not an ‘insurance cut’ but a natural policy response to adverse macroeconomic surprises that have already materialized,” said analysts at Société Générale. The analysts expect more rate cuts, in the fourth quarter of this year and first quarter of 2020, bringing South Korea’s policy rate to 1%.
Bank Indonesia on Thursday cut its benchmark rate by 0.25 percentage point to 5.75%, its first reduction since September 2017. The outcome was largely expected by economists. Analysts at Commerzbank expect up to 0.75 percentage point in additional reductions this year.
South Africa lowered its main policy rate to 6.5% from 6.75%.
For the three central banks that eased policy Thursday, the rate cuts appear more grounded in economic weakness than in some other countries that are trying to safeguard expansions. South Korea’s gross domestic product contracted in the first quarter. Indonesia’s GDP has fallen for two straight quarters. South Africa’s GDP slid 3.2%, at an annualized rate, in the first quarter.
They have something else in common, too: Each central bank had raised interest rates at the end of 2018, giving them a higher base to start with and making it easier to initiate a rate-cutting cycle.
Similarly, the Fed raised interest rates at the end of 2018 to a range of 2.25% to 2.5% and in the early part of this year was still signaling that additional increases were on the horizon. But signs of weaker U.S. growth and stubbornly low inflation have prompted officials to reverse course and hint at a rate cut later this month.
Unlike the Fed and most Asian central banks, the ECB isn’t starting from a positive level for its key policy rate, which has been at minus 0.4% since 2016. Nevertheless, economists expect the ECB to reduce the rate later this summer.
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