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What is the default rate and how it relates to bond and loan prices

Part 3
What is the default rate and how it relates to bond and loan prices (Part 3 of 5)

Fed policy: A factor that pushes the yield curve upwards

Throughout 2013, the trend in long-term interest rates was largely driven by expectations about Federal Reserve policy. As the Chairman Janet Yellen decided that the Fed would start considering “tapering” its bond purchases starting early 2014, long-term interest rates rose steeply, sending the yield on ten-year Treasury bonds up over 120 basis points, and the yield curve steepened. The process of asset repurchase by the Fed is also known as quantitative easing.

Yield CurveEnlarge GraphNow, balancing such an upward tendency of a yield curve would be the economic factors like better-than-expected growth of the economy, low inflation, and demand for credit. As this would keep interest rate steady, the net effect on yield would be moderate. If the pressure on yield lessens, it would help abate the default rate and bond price will get a boost.

Another interesting factor to note here is the performance of non-investment grade junk bonds. Sub-investment grade corporate yield spreads are the lowest they’ve been since before the financial crisis. While it may be possible for yield spreads to continue to decline and drive outperformance relative to Treasuries, there are heightened risks in the high yield market.

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