As treasury yields increased, garbage bonds did the opposite: chasing yields even more frantically on dangerous la-la land

Junk bonds’ revenues have plummeted over the past month to a historic low.

By Wolf Richter for WOLF STREET.

Yields in U.S. Treasuries have soared to several-year highs in recent months, and mortgage rates have risen, yields on investment-grade corporate bonds have risen, and bond funds have suffered losses for both their investors and conservative long-term investors. Term bond funds have been hugely successful – for example, the price of the iShares 20 Plus Annual Treasury ETF [TLT] It has fallen 27% since July 2020 – and all sorts of turmoil has eased in the bond market.

With the exception of junk bonds, especially in the risky segments of the junk market, the frantic chase for yields continues to rage because yield-chasers do not think the central bank’s tightness applies to junk bonds, in fact it does. Bonds are higher than investment grade corporate bonds or treasury bonds because it tightens the financial position – this is the central bank’s stated goal – making it harder for many junk rated companies to provide new credit for service and pay off existing debts. , Which prevents these companies from repaying their current debts, which creates a risky end of the spectrum.

So here we go

Two-year treasury income It rose to 2.53% by Friday, the highest since the 2018 rate-rise phase, and the highest since July 2008, before the financial crisis began to fully blossom.

10 year treasury revenue It rose to 2.72% on Friday, the highest since the February-December 2018 era, before and after 2014, at the end of the Taber Tantrum:

In 2018, the central bank raised rates four times and pumped out assets on its balance sheet at a rate of $ 50 billion a month. Inflation was below or within the target of the central bank. In December 2018, Powell began to bend under the relentless attacks of Trump and the reverse trend.

Now inflation is almost three times higher than the central bank’s target and has become a political beggar for the White House, and the central bank is under pressure to bring it back down, which will not succeed in the long run. But instead, the central bank is chasing it with the slowest rate hikes and the most alarming amount of austerity, even after making a policy error over the past two years and exacerbating these policy errors beginning in January 2021. This rising inflation began to blow. So for now, there will be no Powell pivot for lower fees. Those rates are going to be very slow and high and everyone knows that.

High quality AA-rated corporate bond yields While the average yield has risen to 3.37% since mid – March, slower than equivalent treasury yields is a sign that some yields are being chased away.

During the financial crisis, the 10-year treasury yield was at a maximum of 4.2%, so even for these companies, the average AA rated yield was 8%, as financial conditions were tight:

Madness at the dangerous end of the junk bond spectrum.

Single-B rated junk bondsHowever, it has only risen slightly since September 2021, and more 2022 collapsed from mid-March, When treasury yields were high. On March 15, they reached 6.72%. Last weekend, they were down 6.48%, the lowest level in history.

This yield is still lower than the CPI inflation rate! Investors take greater risks for more negative, but less negative, real yields.

B-rated bonds are medium-sized junk bonds that are considered “highly speculative”. According to my cheat sheet for corporate bond credit ratings, that type is more risky than BB-rated junk bonds (“non-investment quality assumptions”).

At the risk of BB, many companies face sudden downgrades and defaults as financial conditions tighten. Each time financial conditions tighten, there are default waves, and the yield spike, as noted:

CCC- or below rated junk bonds Includes high-risk companies, where cash flow is almost inadequate, and with large losses – companies borrow at the time of borrowing. These types of securities range from a “significant risk” for CCC-rated securities to a “small chance of default immediate recovery” for C-rated securities. According to my Corporate Bond Credit Rating Guide, the next step by default is D.

Average CCC or lower rated bond yields are currently down 10.11% from mid-March (10.36%). During this period, as treasury yields increased, the spread for treasury yields shrank by 81 basis points, which is an indication that this end of the market is on total land.

It is also the type of bond that investors flee to earn above the 7.9% CPI inflation rate. And they are taking great risks to their capital to protect themselves against inflation.

The current average yield, 10.11%, is close to an all-time low. Many of these securities become default when financial conditions tighten to the point where investors are unable to provide new money to pay existing investors. At that time, debt restructuring, often in bankruptcy, may result in the holders of these securities incurring huge losses because these securities may be unsecured or secured by the network.

This means that junk bonds want to do something, and these companies that do not have enough cash to pay off their debts are going to face a new reality of tightening financial conditions, which is what the central bank has set up. Should be done by tightening monetary policies. But for now, that division is on La-La land, where investors are still frantically chasing yields.

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