21 March 2018

Rising Junk-Bond Liquidity Concerns

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According to a Barclays PLC index, U.S. funds investing in debt rated below investment grade lost an average 1.33% in July, their second-worst monthly performance since November 2011. In June 2013, after the Federal Reserve began hinting that it would scale back its monetary easing, they lost 2.62%. The latest junk-bond decline intensified last week as investors continued to make heavy withdrawals of money, in part because of worry that could prompt the Fed to raise interest rates sooner than expected, a move that would likely pressure bond prices.

Reflecting the cautious mind set, some portfolio managers are selling riskier bonds and replacing them with safer ones because of concern about market liquidity. Many investors say liquidity is drying up as the Fed pares its monthly stimulus and large banks trim their bond inventories. Investors pulled more than $5 billion in July from U.S. junk-bond mutual and exchange-traded funds deepening the liquidity fears and adding to concern that the recent selloff could intensify.

The downdraft in junk debt highlights concerns that purchasers in the $1.6 trillion U.S. market, lured by higher income than on government and highly rated corporate bonds, have paid too much for the securities. Many investors say prices have rallied, sending yields to levels too low to compensate buyers for the risk of the investments.

The tremors are being closely scrutinized across Wall Street. Many investors this year have expressed concerns that a pullback in junk-bond prices could signal that market participants are rethinking their willingness to take risk, foreshadowing further declines in stocks and other risky assets. The Dow Jones Industrial Average has dropped seven of the past eight trading days and is down 0.5% this year.

Brian Connolly, co-founder of hedge fund Millstreet Capital Management in Boston, which oversees more than $200 million in assets, recently tried to sell $3 million of energy company bonds but couldn't find buyers for three days which typically such a sale takes a day at the most.

Some investors have used the sales to bulk up on safer securities such as higher-rated corporate bonds and U.S. Treasury debt, fueling the latest rally in the ultrasafe bonds. The 10-year Treasury note on Friday rose in price to yield 2.494%, down from 2.565% at the start of July.

The problem also presents itself when traders need to buy bonds in a hurry. Some investors blame lower inventories at banks that in the past held a lot of bonds to fill client orders. Lately, they have been shrinking those stockpiles to meet tougher capital requirements and gird for an interest-rate increase.

Dealer inventories of high-yield corporate bonds fell to $4.8 billion in early July. That is the lowest level since April 2013, when the Federal Reserve Bank of New York began publishing data for separate types of debt, and down from $7.9 billion the previous week.

Signs are rife that trading is thinner. Just 1.8% of outstanding U.S. bonds changed hands on an average day in the first quarter, down from 2.2% a year ago and a 2002-2008 average of 3%, according to the Securities Industry and Financial Markets Association.

Click here to access the full article on The Wall Street Journal. 

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