Why the IMF is concerned when high-yield bonds reach record highs

Market Realist

Must-know: Analyzing the latest corporate debt investments (Part 3 of 5)

(Continued from Part 2)

The hunt for yield

With interest rates at all-time lows, investors have flocked to the junk bond market in search of yield, pushing prices close to record highs over the past year. Moreover, high-yield exchange-traded funds (or ETFs) have experienced an 18% rise in trading volumes over the past year.

The IMF is concerned

However, in its April Global Financial Stability Report, the International Monetary Fund (or IMF) said that the search for yield has led to a reduction of corporate bond inventory at banks while increasing the share held by households, mutual funds, and ETFs. It now exceeds the share held by traditional institutional investors.

“The concern is that if investors seek to withdraw massively from mutual funds and ETFs focused on relatively illiquid high-yield bonds or leveraged loans, the pressure could lead to fire sales in credit markets,” the IMF said. High-yield bond investors may find their portfolios depreciating rapidly with no way to meaningfully reduce their holdings on account of the illiquid nature of high-yield bonds.

Moody’s LSI declined

However, Moody’s Liquidity Stress Index (or LSI) declined from 4.0% in April to 3.7% in May, indicating that the liquidity of speculative-grade companies has strengthened further—a sign that credit markets remain attractive for issuers despite some shift in demand from loans to bonds.

Popular high-yield bond ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays High Yield Bond (JNK) continue to attract yield-savvy investors, driving prices upwards. The high-yield bond market seems to be performing well along with the equity markets. The S&P 500 index (SPY), which gauges the performance of the 500 largest U.S. multinational companies, like Exxon Mobil Corp. (XOM), and Microsoft (MSFT), is already up 27 points since it breached the 1,900 mark on May 23.

The next part of this series assesses the issuance and fund flows into high-yield bonds in the past week.

Continue to Part 4

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