With more traders getting nervous about the market, riskier high-yield, junk bond exchange traded funds are mirroring the sell-off in equities and could experience continued volatile swings after investors pushed up prices and tightened spreads.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest junk bond ETFs by assets, both fell 0.5% Thursday during the broad market sell-off. In contrast, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), which tracks investment-grade debt, rose 0.3%.
While riskier assets tend to perform better in an expanding economy, junk bonds are losing steam as investors weigh in on the negative effects of the Federal Reserve reversing years of loose monetary policies that helped fuel the market rally, reports Mike Cherney for the Wall Street Journal. [Tempering Rate Risk With Corporate Bond ETFs]
Typically, a stronger economy is good for bondholders since rising employment helps create demand, which will help debt issuers to sell more goods to pay down their debt.
However, a strong economy now would prompt the Fed to hike rates, which could lead to rising defaults, especially among companies that have high leverage and low ratings. For instance, corporate borrowings have risen to two times earnings as of March 31, compared to 1.76 times at the end of 2010, according to Morgan Stanley. Moreover, some are concerned that companies have been implementing share repurchases at the fastest pace since the financial crisis, which would leave firms with less cash to pay back debt.
Bond prices are high and “fundamentals are very strong, but getting a little worse,” Jim Swanson, chief investment strategist at MFS Investment Management, said in the article.