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Bond market turmoil

The Financial Times was among news sites following up on the disaster we mentioned last week in the “junk,” or high-yield, sector of the US bond market. Eric Platt, one of these reporting recently on the FT site, sees a growing problem:

After years of ignoring the low credit ratings and indebted balance sheets of companies within the junk bond sector, a wave of redemptions for three funds — forcing two to shutter in the past week — has triggered a frisson across the US fixed income market.

With the US Federal Reserve expected to nudge overnight borrowing costs up from near zero on Wednesday, the $1.3tn junk bond market has already begun counting the cost of the easy money era.

While much of the pain reflects heavily indebted gas drillers and miners hit hard by a collapse in commodity-based revenues, the pain in junk has spread to other sectors, suggesting that years of booming debt sales are catching up with companies and investors.

As the figure in my previous post showed, “junk” yields have been climbing for about a year and a half, while yields on US Treasury bonds have remained steady during this period. Spurs for the rise in yields in this high-risk category include problems in the energy sector, which has been the victim of declining commodity prices.  Renewed declines in prices for oil and other commodities, along with the general loss of confidence in bonds, have also had a great impact on the market for the debt of fast-growing “emerging market” economies that rely to a great extent on commodity exports. In broad emerging market indicies, we see a reprise of the escalation of yields that occurred at the end of last year. Issuance of emerging market debt to exuberant and yield hungry buyers had soared in recent years.

Moreover, leveraged loans, which are used by many private equity firms to finance purchases of companies, have been proving difficult to unload to investors in recent months. As the New York Times explained last month,

Banks make these loans to companies that have junk credit raitings in the hope of of quickly selling the debt to investors, including mutual funds, hedge funds an entities called collateralized loan obligations.

As the Times reported in the same article, investment banks trying to sell to the market the liabilities of firms deemed marginally creditworthy have been finding themselves taking losses. The firms in this business “appear to be sitting on potential losses that may exceed $600 million, according to an analysis by debt market specialists of several deals that are struggling.”

In the midst of the turmoil discussed in my previous post after a big bond fund more or less barred withdrawals, the New York Times reported that the situation “ignites fears that mutual funds that have loaded up on hard-to-sell securities like junk bonds, leveraged loans and emerging market debt may face a similar predicament.” More broadly, “some see the turmoil as a warning sign of a broader slowdown in the economy, as companies, many of which have borrowed heavily in recent years, struggle to pay down their loans.”

The domestic nonfinancial business sector was often described during the recent mortgage debt crisis as relatively unscathed by the financial problems experienced by US households. But when firms are too indebted, and when they find it more difficult to obtain loans, they are likely to spend less money on capital goods, research, etc.



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