In the previous part of this series, we described how an easy money policy and a stable credit outlook had enabled high yield issues at record-low yields and low credit spreads over investment-grade issues. This article will assess the impact of monetary tightening on credit spreads between investment-grade (AGG) and high-yield (HYG) issuers.
Now with the Fed continuing with the tapering of its monthly asset purchases, and also providing some guidance on when the Fed funds rate is expected to increase (a few months after the end of tapering, probably in 2015), yields are expected to increase for both investment-grade and non–investment grade bonds. With investment-grade bonds (AGG) expected to offer higher yields, other factors remaining constant, investors may prefer to invest in them, especially if they believe the credit spread has been inadequate in the past. This factor would cause yields for high-yield bonds to increase more than yields for investment-grade bonds and prices to fall. One ETF that invests in investment-grade bonds is the Core Total U.S. Bond Market ETF (AGG), which tracks the Barclays U.S. Aggregate Bond Index.
The Fed’s stance as well as increases in credit risk are some of the reasons why short sellers expect the prices of high-yield bonds to decline as yields increase across the bond spectrum. So, the short interest ratio, or the number of shares of a security or ETF that have been sold short by short sellers, increased to ~25.9 million on February 28, 2014, for JNK and ~30.2 million on February 14, 2014, for HYG—an all-time high. The short interest ratio for JNK represents over 10% of total shares outstanding (~248.5 million), while the short interest ratio for HYG represents almost 21% of the total shares outstanding (144 million). Top holdings in HYG include Sprint 144A 7.875% (S), with 0.57% of total assets, and Sallie Mae 8.45% (SLM), with 0.39% of total assets.
On March 24, student lender Sallie Mae (SLM) sold $850 million 6.125% ten-year bonds with a spread of 351.6 basis points over ten-year Treasuries. The issue is rated Ba1 by Moody’s.
To find out about the nature of risks undertaken by short sellers, read on to Part 6 of this series.