The Rising Cost Of Junk: European High Yield Bonds In Negative Territory
The volume of the world’s non-financial corporate debt has generally skyrocketed over the past decade, driven in large part by ultra-low, zero, and even negative interest rate policies at several global central banks.
To date, the lower rate environment, combined with several variations of quantitative easing (QE) measures at certain central banks, including the U.S. Federal Reserve and the European Central Bank (ECB), has spurred investors to assume more risk.
Indeed, QE’s effects of flooding the financial system with liquidity has been blamed by many in the market for inflating asset prices and responsible for massive debt bubbles.
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Continued monetary policy easing at the ECB, for example, has helped push debt levels across the continent higher by more than 11.3% since it moved to a zero interest rate policy (ZIRP) in early 2015.
In fact, in the wake of the housing market crash and credit crunch, the euro area’s non-financial corporate debt has surged from about US$11.7trn at the end of September 2007 to nearly US$14tn at the end of 2018, according to the Bank for International Settlements (BIS).
Meanwhile, other global central banks, which have also maintained ultra-low interest-rate, ZIRP or negative interest rate policies (NIRP) at least since December 2008, including the Bank of Japan, the Swiss National Bank, Sweden’s Riksbank and the U.S. Federal Reserve, have triggered a spike in their respective nation’s debt levels.
As of December 2018, the BIS has recorded the amount of non-financial corporate debt as a percentage of GDP in the euro area, Japan, Switzerland, Sweden, and the U.S. as 105%, 102.6%, 118.1%, 155.5%, and 74.4%, respectively.
Against this backdrop, bond investors have grappled with higher prices in their local primary markets, generally turning instead to the U.S. for more attractive yields.
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In Europe, for instance, several newswires have published reports of at least 14 junk-rated companies that have bonds in the secondary market trading with negative yields, including Finnish telecoms firm Nokia (NYSE: NOK), Irish paper packager Smurfit Kappa Group (OTCMKTS: SMFKY), as well as the European financing arm of U.S. medical tech company Becton, Dickinson and Co (NYSE: BDX).
Intraday Tuesday, Nokia’s March 2021 notes were bid at around -0.07%, Smurfit’s January 2020s were bid at almost -0.570% and Becton, Dickinson’s June 2021s were nearly -0.05%. These yields compare favorably to certain European government bonds, with Finland’s and Germany’s 2-year notes last bid at -0.73% and -0.75%, respectively, while the yield on Ireland’s 1-year note was about -0.63%.
Analysts at Janney Montgomery noted that it is “a funny thing when yields go negative, though, in recent years, the situation has become more commonplace.” They observed that credit and liquidity risks are “not at a minimum by any measure and economic data has been softening, so” some European high yield corporates moving into negative-yielding territory “is a reminder that everything is relative.”
Janney added that when regional rates “seem to be lower for longer, and with the U.S. switching more dovish, alternatives to pick up yield are becoming few and far between. That thought is driving returns in the U.S. high yield market, which remain above 10% year-to-date.”
For the week ended July 10, 2019, Thomson Reuters/Lipper U.S. Fund Flows reported US$37m of outflows from international and global debt funds, while investment-grade and high yield funds witnessed inflows of US$570m and US$619m, respectively.
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In the meantime, it appears that with the Fed and ECB each recently pointing to escalating geopolitical uncertainties, stubbornly low levels of inflation, and other risks tilting to the downside, many market participants expect further easing measures on the near-term horizon.
Market participants will likely be closely watching the ECB, when it meets next to decide on monetary policy in Frankfurt on July 25, while the Fed’s Open Market Committee will next decide on its next interest rate move at the conclusion to its two-day meeting on July 31.
For a full list of U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more, select the Event Calendar option in the IBKR Trader Workstation.
The author does not hold any positions in the financial instruments referenced in the materials provided.
The analysis in this material is provided for information only and is not and should ...
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