(Repeats story first published on March 5, no text changes)
* Junk bonds offer a positive return in broken bond markets
* The riskiest debt rated CCC outperforms
* Corporate bonds could be affected if US yields rise further
March 8 (Reuters) – Junk bonds, the only fixed income segment still offering positive returns this year, will continue to outperform, investor bets say the US Federal Reserve will eventually put a foot down and calm bond markets .
The sector, with credit scores below BBB-minus, is among the riskiest debt categories. But it weathered the February stock market storm better than most, offering annual returns of around 1%, according to the BofA indices. . Sovereign and investment grade corporate bonds are in the red.
Certainly, corporate debt could face greater challenges in the months to come.
Last month’s bond sale was fueled by real Treasury yields which hit multi-month highs. If this continues, with rising bond yields exceeding inflation expectations, it could be dangerous as it represents an increase in the real cost of capital.
But if central banks control real yields, rising bond yields due to inflation expectations should support companies.
“High yield (debt) is one of the few remaining asset classes that gives you a positive return after inflation,” said Azhar Hussain, head of global credit at Royal London Asset Management.
“That’s why, if you want to shelter yourself from an inflationary storm, high yield will be the ideal place to come and hide.”
A global high yield BofA index currently returns around 4.4%. An index tracking good quality debt from the main markets returns 0.9%.
On an inflation-adjusted basis, bad US bonds return 2%, compared to minus 0.1% for investment-grade peers and minus 0.7% for 10-year Treasuries.
The world’s largest asset manager, BlackRock, recently downgraded sovereign bonds, but said he still likes high yield.
CUSHION
The punt depends on the Fed stamping any significant increase in real yields.
The facade showed signs of cracking last Thursday, when 10-year Treasury yields surpassed 1.60%, putting junk debt on its worst day since November. Junk bonds sold out again on Thursday when Fed Chairman Jerome Powell disappointed markets.
BlueBay Asset Management chief investment officer Mark Dowding said a rapid rise in 10-year Treasury yields to 1.75% would lead to a pullback.
John McClain, high yield portfolio manager at Diamond Hill Capital Management, sees 2% as the pain point, expecting the bond market to “force Fed or Treasury action” before that.
2% 10-year Treasuries would equal 0% real yield, ING Bank analysts calculate.
Deutsche Bank strategist Jim Reid is among those who believe the corporate debt burden will force central banks to act. A sustained rise in real yields can push up the premiums paid by corporate bonds, which they are unlikely to allow.
Another layer of protection is the short term / high coupon structure of the reduced rate bonds, the so called shorter duration, which makes them less immediately sensitive to changes in interest rates. This was one of the reasons for the resilience of the sector last month.
The shorter the term, the faster investors will recoup their initial investment in the bond through coupon payments. So in a massive sell off, the higher coupon payments that result from buffer losses resulting from the fall in the price of the bond.
The average duration of the BofA US High Yield index is around five years, compared to around seven years for the US Treasury index, according to Refinitiv Datastream.
“(Investors) have to look for coupon income to deal with these spikes in yields, otherwise they would lose value. The only asset right now that can offer a buffer against this rise in yields is the junk, ”said Althea Spinozzi, bond strategist at Saxo Bank.
The riskiest and most profitable junk segment, rated CCC and below, generated 4% higher returns in Europe and the United States this year, and outperformed during the market rout.
For the junk to take a hit, short-term lending rates would have to rise, notes Hussain of the Royal London. But these have been remarkably stable, with two-year Treasury borrowing costs unchanged this year, contrasted with strong long-term increases.
Meanwhile, vaccinations and lower default expectations this year give investors greater comfort in holding debt from sectors exposed to COVID. McClain, for example, says he has “aggressively pivoted to areas most exposed to COVID, such as travel, recreation and gaming.”
Reporting by Yoruk Bahceli; additional reporting by Kate Duguid in New York; edited by Sujata Rao, Larry King
