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Junk bonds still in the-la-land as investors seek yield – the risks are damned.
By Wolf Richter for WOLF STREET.
The bond market stabilized on Friday. And that was a good thing for the Wall Street crybabies which had started hyperventilating on Thursday, when the 10-year Treasury yield, after rising for months and accelerating in the past two weeks, climbed to 1.52. %, having since tripled. August.
By Thursday, all sorts of complex leverage deals had come apart and the hard sell took hold. By historical standards, and given the current inflationary pressures, these yields, even Thursday, were still surprisingly low. But Wall Street had a cow, that’s for sure.
On Friday, the 10-year Treasury yield fell 8 basis points, as part of Thursday’s 14 basis point peak, and closed at 1.44%, still higher than a year ago, the February 21, 2020.
Yields rise because bond prices fall, which produces a world of suffering – which is reflected in bond funds focused on long-term Treasury bonds, like the iShares 20 Plus Year Treasury Bond ETF [TLT]; its price is down about 16% from the start of August, after Friday’s 3.3% rebound.
The Fed approves.
Federal Reserve Governors spoke with one voice about rising Treasury yields: it’s a good sign, a sign of rising inflation expectations and a sign of economic growth. This is the mantra they keep repeating.
Fed Chairman Jerome Powell called the surge in Treasury yields a “statement of confidence.”
Kansas City Fed Chairman Esther George said Thursday: “Much of that increase likely reflects growing optimism about the strength of the recovery and could be seen as an encouraging sign of rising expectations for the recovery. growth.
St. Louis Fed Chairman James Bullard, one of the most passionate doves, said on Thursday: “With improving growth prospects and rising inflation expectations, the corresponding rise in yield 10-year treasury is appropriate. ” Investors demanding higher yields to offset higher inflation expectations “would be a welcome move”.
They’re all singing from the same page: they’re easy going about QE and low fares. But they’re going to let long-term rates rise, which is starting to pack some of the ridiculous scum in financial and housing markets.
These statements from the Fed Thursday morning in support of rising long-term yields – as markets demanded otherwise, more QE but focused on long maturities to lower long-term yields – likely also helped to confuse Wall Street.
But on Friday, the mini-panic was restored, and that’s good because a real panic could change the attitude of the Fed.
On Friday, the 30-year yield fell 16 basis points to 2.17%, erasing the jump from the previous three days. This is now where it was on January 23 of last year:
The yield curve measured by the difference between the 2-year yield and the 10-year yield had steepened sharply as the 2-year yield remained in place and the 10-year yield took off. On Friday, the gap between the two narrowed to 1.30 percentage points from 1.35 percentage points on Thursday, still the steepest yield curve on this measure since December 2016.
In August 2019, the yield curve by this measure briefly “inverted” when the 10-year yield fell below the 2-year yield, making the spread negative. Since then, the yield curve has steepened very sharply:
And mortgage rates finally started to follow.
The 30-year average fixed mortgage rate fell to 2.97% in the week ending Wednesday, as Freddie Mac reported on Thursday. This does not yet include the movements of Thursday and Friday.
The 30-year mortgage rate normally tracks the 10-year yield quite closely. But in 2020, they went offline. When the 10-year yield started to rise in August, the mortgage market simply ignored it, and mortgage rates continued to fall from an all-time high to an all-time high until early January, causing the market to explode. immovable.
But in early January, mortgage rates started to climb and are now up 32 basis points in less than two months – although they remain historically low.
Note the disconnect in 2020 between the weekly 10-year Treasury yield (in red) and Freddy Mac’s weekly measure of the 30-year average fixed mortgage rate (in blue):
In this incredibly foamy and overvalued bubble real estate market, higher mortgage rates will eventually raise doubts.
And that too seems to be smiled with approval by the Fed. They are not blind. They see what’s going on in the housing market – what risks stack up with this kind of house price inflation. They just can’t say it out loud. But they can let long-term returns increase.
Mortgage rates have some catching up to do. The spread between the average 30-year fixed mortgage rate and the 10-year yield has been narrowing steadily since the March madness, and at 1.37 percentage points, it is the narrowest since April 2011.
The gap always returns from extreme lows, like this, to the mean. It can do this in two ways, by raising mortgage rates faster than Treasury yields or by falling more slowly than mortgage rates.
High quality corporate bonds are starting to feel the pain.
Yields have risen and prices have fallen across the spectrum of investment-grade corporate bonds, although yields remain very low based on historical metrics:
AA-rated bonds returned an average of 1.81%, according to the ICE BofA AA US Corporate Index, against the record low of 1.33% in early August (my cheat sheet for corporate bond ratings).
BBB-rated bonds – just above junk bonds – have come out of their sluggishness over the past two months, with average yield climbing to 2.39%, according to the ICE BofA BBB US Corporate Index, from the record low 2.06% at the end of December. They, like mortgage rates, had continued to fall through 2020, despite rising Treasury yields.
Junk bonds still in la-la-land, with returns close to record lows.
BB-rated bonds – the highest-rated junk bonds – have come out of their torpor just over the past two weeks, and the average yield has risen to 3.45%, according to the ICE BofA AA US Corporate Index, up by compared to the lowest record in the middle. February by 3.20%.
The average yield on CCC-rated bonds – at the riskier end of the junk spectrum with considerable probability of default – has barely recovered from record lows in mid-February (7.17%) and now hovers at 7.27%. By March, the yield had climbed to 20%. During the financial crisis, it had climbed north of 40%.
The Fed smiles at its creation.
The fact that the riskier bonds are still posting yields close to their all-time low is a calming sign for the Fed. This means that the financial conditions are still extremely easy. All kinds of high-risk companies with squashed incomes and huge losses – think cruise lines with almost zero incomes and losses – can fund their cash consumption by issuing large amounts of new bonds to over-eager investors. seeking returns, no problem.
So far this year, companies have issued $ 84 billion in junk bonds, according to at Bloomberg. At this rate, the first quarter will be the largest ever issued in bad bonds. There is a huge demand for bad bonds due to their higher yields – the risks are damned. The hunt for yield is underway. And the global junk bond market has soared to over $ 1.6 trillion.
For the Fed, this is one of many signs that the credit markets are still very foamy, even as Treasury yields have fallen from historically low levels to historically low levels. While he has promised to continue QE and not to hike rates for “a while,” he is also telling the markets in a unified voice that rising long-term Treasury yields are a sign that the Fed’s monetary policies are working as expected. And those higher long-term yields are removing some of the scum from the markets, possibly including the housing market – and I don’t think that’s an unintended side effect.
From crisis to crisis, and even in the absence of a crisis. Read… Fed QE: Assets reach $ 7.6 trillion. Long-term Treasury yields rise nonetheless, Wall Street Crybabies cry out for more QE
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