Interest rates are the price of money. If a bank charges a borrower 5%, for example, they say the price for using the money for that borrower is 5%.
From the borrower’s perspective, the interest rate describes the value they place on that money. If they buy a car with a loan, economists say the borrower believes the car will improve quality of life by at least 5%. Otherwise, they would not accept this interest rate.
This assumes that the borrower performs complex calculations. In many cases, this is not the case. Borrowers just want the car and pay the market rate.
Lenders, usually banks and other large institutions, are rational. They set prices based on factors that history considers important.
The interest rates generate a profit for the lender. The rate also compensates for the expected loss of purchasing power due to inflation. Finally, interest rates compensate the lender for the risks associated with defaults.
These factors are included in all interest rates. This means that with high yield bonds paying just 4.2%, the lowest rate in history for this risky asset class, investors are ignoring the risks of inflation and default.
Junk Bonds paying less than ever
Junk bond traders act like default isn’t a risk
More commonly known as junk bonds, high yield bonds are issued by the riskiest companies.
Due to the risk of default losses, lenders usually charge relatively high rates. Now, junk bonds are only yielding 3.2% more than ten-year Treasury bills. At the end of the last recession in 2009, junk bonds were trading with average interest rates more than 10.5% higher than ten-year treasury bills.
Despite the low level of risk embedded in bonds, default risks are higher than average. According to CNBC, “S&P Global Ratings said the high yield, or rotten bond default rate is heading towards 10% over the next 12 months, more than triple the rate of 3.1% that closed 2019. . “
If defaults triple, junk bond investors will lose trillions of dollars. This risk is priceless in the market. In fact, interest rates indicate that forex traders are ignoring all the risks and prices in the best economy seen for over twenty years.
If you have unwanted bonds, now may be the time to sell.
Michael carris an authorized market technician forBanyan hillPublishing and the publisher ofA shop,Peak Velocity TraderandPrecision Profits. He teaches technical analysis and quantitative technical analysis at the New York Institute of Finance. Mr. Carr is also the former editor of the CMT Association newsletter,Technically speaking.
Follow him on twitter@MichaelCarrGuru.