Fixed-income investors have enjoyed generating attractive yields from their speculative-grade debt and junk bond exchange traded fund investments. However, many are now exposed to rising credit risks, especially as the Federal Reserve plans to hike interest rates.
Year-to-date, the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) saw $2.4 billion in net inflows and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) attracted $2.1 billion, according to ETF.com.
However, junk bond investors face growing risks as companies look to refinance debt with interest rates beginning to rise, reports Matt Turner for Business Insider.
“The key question is: will credit markets be able to absorb the refinancing needs of lower quality high yield and leveraged loan borrowers?” Matthew Mish and Stephen Caprio, strategists at UBS, asked in a note.
The UBS strategists argue that roughly 35% to 40% of outstanding U.S.high yield and leveraged loan debt, or roughly $1.05 trillion to $1.2 trillion in low quality speculative-grade debt outstanding “is at risk.”
Risky borrowers “cannot pay down debt because cash flow generation is weak, and now interest costs are rising,” according to the UBS strategists. “So the Fed is explicitly condoning rising default rates. Finally, it is our humble belief that the consensus at the Fed does not fully understand the magnitude of the problems in corporate credit markets and the unintended consequences of their policy actions.”
According to ratings agency Standard & Poor’s, default rates are already inching higher, with the trailing 12-month rate rising to 2.8% in November, the highest level in three years, reports Jeff Cox for CNBC. The ratings firm anticipates defaults to hit 3.3% by September 30, 2016.