Junk bond ‘rally’ tells a deceptive story

The junk bond market’s magic number is 4.56. First, the average yield for the Bloomberg Barclays US corporate high-yield index plunged the most in seven months to 4.56% on November 9, easily breaking the previous all-time low of 4.83% set in June 2014. Then, data compiled by Refinitiv Lipper found that investors poured $4.56 billion into US high-yield bond funds in the week ended November 11, the seventh largest inflow ever and the largest since June. It’s a strange coincidence, no doubt, though both figures would seemingly indicate that traders are getting increasingly comfortable with owning debt from some of the riskiest companies, even as Covid-19 outbreaks and hospitalisations escalate across America and the globe.
I’m skeptical of this latest junk-bond rally, and not just because yields have bounced back up from the record lows set on a day of unbridled Covid-19 vaccine optimism. The all-in 4.56% yield on a $1.52 trillion index comprising more than 2,000 separate bonds of various credit quality is deceiving in more ways than one.
For starters, credit investors tend to focus primarily on the yield spread above US Treasuries. The average maturity of the high-yield index is 6.4 years, so the seven-year Treasury note is a decent benchmark. That rate has climbed to 0.64% from as low as 0.355% in early August, but the current yield is still well below historical market levels. From that perspective, it’s only natural that all-in yields on junk bonds would be lower as well. But the average spread, in contrast to yields, still hasn’t recovered to pre-Covid levels.
There’s also the undeniable fact that indexes can change — often dramatically — during periods of intense credit pressure. As Bloomberg News’s Katherine Greifeld noted last week, three of the five largest companies in the high-yield index are behemoths that entered the year with investment grades but since became “fallen angels.” Those three — Ford Motor Co, Occidental Petroleum Corp and Kraft Heinz Co — are still rated in the double-B tier. And investors see Ford and Kraft in particular as relatively safe bets: Ford bonds due in 2026 yield just 3.5%, while Kraft Heinz debt with a similar maturity yields just 2.4%. The increased proportion of these higher-rated junk bonds would seemingly bring down the overall index yield.
But even that doesn’t quite tell the entire story. Because investors are typically willing to lend money to investment-grade companies for decades.
—Bloomberg