The high yield bond market has taken a considerable hit over the past few weeks since Bernanke spooked the markets with talk of early quantitative easing tapering. The weeks after the June FOMC (Federal Open Market Committee) meeting saw a fall of approximately 75% in issuance volumes. The lower issuance and investor hesitance to buy long-dated bonds due to duration risk led to broad price declines across the board, reaching over 4% losses at some point. Since then, the market has bounced back slightly, and bond prices are more stable.
Nonetheless, the higher new issue yields spiked and remained higher, reaching 7.7% in June from 6.0% in May. The higher yields have led to price drops across the board, as investors reprice existing bonds in the secondary market relative to the new issues.
Fund flows back in black
Fund flows into high yield mutual funds returned to positive territory after several weeks of outflows. Last week saw a very solid $449 million inflow. Anecdotal evidence suggests investors feel that most of the downside risk from higher interests is already priced in and bonds may now be cheap. Others are hoping for a pullback in the near term. The high yield index managed to close 0.13% higher for the week.
Limited room for pullback
However, since Treasuries have moved from 1.6% in early May to 2.6% in early July, there’s very limited room for a pullback in high yield bond yields. The Treasury rates are very likely to remain at least above 2.5%, given expectations of early quantitative easing by the Fed. Furthermore, recent positive jobs data solidified the expectations that the economy is improving and increased the chances of the Fed taking action soon.
© 2013 Market Realist, Inc.