Continued spread compression overcomes higher rates
The SPDR Barclays High Yield Bond ETF (JNK) ended the week unchanged even as interest rates increased on the release of the FOMC minutes on Wednesday. The ETF has had a strong recovery from its summer low of $38.70 to regain its May high on the year. Rising rates continue to mask just how strongly high yield has performed this year, with massive spread compression (the difference between bond yields and Treasury yields) compensating for higher rates.
YTW (yield-to-worst, a measure of the implied annualized return on a bond if the worst-case scenario happened outside of a default) is at 5.88%, nearly 50 basis points lower than the 6.3% seen in September. The yield is at all-time lows, but the spread to Treasuries was much lower in 2005 and 2006. As the yields on the five-year and the ten-year have widened, spreads have fallen from 540 basis points to 470, so implied credit risk has fallen, reflecting about a 2% default rate going forward. In light of these factors, JNK and the iShares High Yield Bond ETF (HYG) saw inflows of $47 million on the week.
Issuance driven by high demand and strong markets
Robust market conditions have allowed issuers looking to refinance for capex, M&A, or dividend payments to raise capital. The financial conservatism seen in the early years of the recovery is starting to wane, but while covenants have loosened, they haven’t been crazy.
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