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Bond investors sticking with junk

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26 Oct 2021

Investors staying in high-yield bonds while losing money reflects the scarcity of opportunity to earn return in the debt markets, finds Andrew Holt.

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Investors staying in high-yield bonds while losing money reflects the scarcity of opportunity to earn return in the debt markets, finds Andrew Holt.

junk bonds

Investors staying in high-yield bonds while losing money reflects the scarcity of opportunity to earn return in the debt markets, finds Andrew Holt.

In what is an unprecedented move, investors in European junk bonds are accepting interest payments that are lower than eurozone inflation levels.

The yield on the ICE BofA index of European high-yield bonds was pushed down to 2.34% recently, marking the first-time buyers of high-yield European currency bonds having to accept payments below consumer price inflation in the eurozone, which hit a decade high of 3% in August.

Analysts assessing the situation pointed to one conclusion: investors willing to extend credit to this riskiest of investments while losing money in real terms reflected the scarcity of other opportunities to earn returns in debt markets.

At the same time, Europe’s solid recovery from the pandemic has reduced the risk that junk bond issuers will default.

In early September, the European Central Bank (ECB) announced a slowdown in the pace of its bond purchases in response to improvements in the economic outlook and growth in inflation.

The ECB’s €1.85trn (£1.6trn) pandemic emergency purchase programme had been buying €80bn (£68bn) of bonds a month or much of this year to keep financing conditions favourable. Yet many investors believe it will be some years before the ECB stops buying bonds and starts raising its deposit rate from its record low level of minus 0.5%.

The central bank’s extremely loose monetary policy has already driven yields on other classes of eurozone debt into negative territory, leaving investors looking to earn a return on their capital.

The yield on Germany’s benchmark 10-year bonds has risen from close to record lows but is still running at about minus 0.35%. The effective yield on the ICE BofA index covering investment-grade European corporate bonds stands at 0.2%.

In what could be said to be an interesting move, credit rating agencies have been upgrading bonds from junk status at an unusual rate, with €7bn (£5.1bn) of European high-yield issues having been pushed up to investment grade in the past 12 months.

This stands in contrast to the average €7bn worth of bonds that had been downgraded in each of the past five years, on average.

European investors in junk bonds are not alone. Investors in US high yield debt are also accepting yields that are below recent rates of inflation.

The average yield on the ICE BofA US high-yield index is just north of 4%, while US consumer prices rose 5.4% in July compared to the same month last year.

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