High yield bonds
High yield bonds, also known as junk bonds, are debt instruments issued by companies. What makes them high yield, or junk, and different from other types of bonds, is the rating issued on them. Rating agencies Standard & Poor’s, Moody’s and Fitch Ratings issue ratings for debt instruments. Bonds with ratings of BB and below by Standard & Poor’s and Ba and below by Moody’s are considered to be high yield.
Yields since the March policy
Yields on high yield bonds, as measured by the BofA Merrill Lynch US High Yield Master II Effective Yield, have fallen since early March. They ended March 15 at 8.39% and actually rose by four basis points the next day. Yields fell thereafter but have been flat compared to their March 15 level, as of March 24.
While the spread between high-grade corporate bonds and Treasuries of similar maturity, as measured by the BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread, which was at 7.5% when March began, fell by over 50 basis points on March 24, it has actually increased since March 15. This is the opposite of what high-grade bonds have experienced.
Junk bond issuers became cautious about hitting the primary market after the release of the March policy statement. Though subsidiaries of Avis Budget Group (CAR) and CNH Industrial (CNHI), along with Radian Group (RDN) and Clean Harbors (CLH), did issue bonds in the week ending March 18, the issuance volume was lower than in previous weeks. However, issuance picked up a week later and was recorded as the highest weekly issuance in 2016.
Lipper data showed that $2.2 billion worth of funds flowed into high yield bond funds for the week ending March 23, making it the sixth consecutive week of inflows.
High yield bonds are different from their cousins in the sense that they act more like equities than like bonds. Flows coming into high yield bonds show that investors have begun investing in these instruments to get that extra yield. This is because even though yields and spreads are high, they’ve fallen from double-digit levels (yields) seen in February 2016. Improvement in credit conditions has brought issuers back to the market, as well.
Retail investors should be watching for further improvement in economic conditions. Given that macro factors take some time to show their impact on numbers, economic conditions may see some deterioration in the future. If consumer spending keeps the US economy in good shape, though, investors can take on exposure to high yield bonds via active (HAHAX) (PHIGX) and passive funds (JNK) (HYG).
In the next part of this series, we’ll get back to the original question at hand: Was the Fed ultra-dovish in its March policy statement?