Despite concerns over debt issued by energy producers in a quickly falling oil market, corporate bond markets and related exchange traded funds face low default risks.
Corporate bonds, notably high-yield speculative-grade debt, have been stuck in sideways trading, with the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) up 0.5% and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) down 0.3% over the past year, as skittish investors held off on concerns that oil companies would miss payments due to lower oil prices. [High-Yield, Junk Bond ETFs to Diversify A Fixed-Income Portfolio]
However, according to Moody’s Investors Service, a strong U.S. economy, improved corporate earnings and light maturity calendar will all help counterbalance falling oil prices and keep corporate default rates below historical averages this year, reorts Vipal Monga for the Wall Street Journal.
“A lot of people have been surprised,” Albert Metz, a Moody’s analyst, said in the WSJ, referring to the low default rates. “But the fundamentals are there. So far, so good.”
Specifically, Moody’s calculates that global default rates could rise to 2.7% in 2015 from 2.1% in 2014, compared to the average default rate of 4.7% since 1983.
Nevertheless, some market observers are still worried that smaller oil exploration and production companies are seeing severe discounts on their debt and rising yields, which could signal potential defaults.
“Many of the credits in the exploration and production space, are deeply distressed,” Matthew Fuller, analyst for S&P Capital IQ LCD, said in the article.
For instance, Energy XXI Ltd bonds are trading at 44 cents on the dollar. HYG includes three Energy XXI debt securities that make a little over 0.1% of the ETF’s overall portfolio.
However, as Joseph LaVorgna, chief U.S. economist for Deutsche Bank notes, the energy sector accounts for an “extremely small portion” of total U.S. employment and the impact of low oil prices on industry defaults could be contained. Additional LaVorgna points out that the benefits of cheap gas for large employers as an input cost would help offset any potential losses from smaller oil producers.
Moody’s, on the other hand, expects the most defaults to come out of U.S. consumer services sector.
SPDR Barclays High Yield Bond ETF
For more information on corporate debt, visit our corporate bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.