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Why did returns on high yield debt turn negative?

Phalguni Soni

Why did trends diverge for corporate borrowers? (Part 4 of 9)

(Continued from Part 3)

Negative returns

Yields on high yield (HYG) bonds as measured by the BofA Merrill Lynch US High Yield Master II Effective Yield fell to a record low of 5.16% on June 23. This level was lower than the former record low of 5.18% from June 20. Week-over-week, though, yields increased 3 basis points to 5.21% on June 27. Let’s see why this happened.

Yield spreads between high yield debt (JNK) and Treasuries also increased over the week. The BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread widened by 12 basis points over the week. It came in at 3.48% on June 27. A widening spread shows you that investors think high yield debt securities mean higher risk.

The yield-to-worst on high-yield debt, as measured by the BofA Merrill Lynch US High Yield Master II Semi-Annual Yield to Worst, increased by 6 basis points over the week. It came in at 4.92% on June 27. On June 20, semi-annual yields-to-worst on high yield debt were estimated at 4.86%—a new historical record .

The yield-to-worst is the lowest and most realistic yield you can expect. It’s the lower of the yield-to-call and the yield-to-maturity on debt securities. Municipal bonds (PZA), mortgages, and mortgage-backed securities (or MBS) are usually callable.

Impact of Wednesday’s economic releases

On Wednesday, June 25, two major economic reports came out. They were way below market expectations.

The U.S. Census Bureau released the durable goods orders report for May. Durable goods consist of items expected to last three or more years. So the report economists and analysts both keenly watch the report, as durable goods orders have multiplier effects on production and sales in other industries as well. After April’s 0.8% month-over-month surge, durable goods orders declined 1% in May. This was a bearish indicator for the economy.

In an important economic update, the Bureau of Economic Analysis released its third and final estimate for first quarter GDP. First quarter GDP declined 2.9% over Q4 2013. This was one of the biggest downward revisions since 1976. You can hold poor weather, along with revisions in healthcare costs and other consumption expenditure, responsible for the fall.

The S&P 500 Index (VOO) took the weather-affected GDP revision in stride. It rose 0.5% to close at 1,959.53 on Wednesday, June 25. But high yield debt investors were less sanguine. As you saw earlier, high yield debt yields and spreads tend to fall when the economy is going up, and vice-versa. Due to the sub-par economic data, yields rose from historical lows and spreads widened Wednesday through Friday on the week of June 23.

Analyzing key trends

In the next part of this series, you’ll find key trends in investment-grade corporate bonds for the week ended June 27. Please read on.

Continue to Part 5

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