Fixed-income investors are returning to junk bond exchange traded funds after the energy-default scenario never panned out. However, speculative-grade debt traders should be wary of a potential interest rate hike ahead.
Year-to-date, the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) gained 3.5% and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) rose 3.0%.
According to Standard & Poor’s ratings service, higher interest rates ahead could lead to steeper borrowing costs and potentially lower investment demand due to risk aversion, reports Amey Stone for Barron’s.
“Despite the heightened risks associated with speculative-grade issuers, these borrowers have had little trouble attracting lenders in the U.S. due to the persistently low interest rates,” S&P credit analyst David Tesher said in a note. “However, we forecast a possible tightening of market access for these prolific issuers in the third and fourth quarters of 2015, as lenders become less yield-hungry and more selective about extending credit.”
Lenders would likely become more selective as higher borrowing costs would increase the risk of defaults, especially in the energy sector where a persistent low oil outlook could continue to undermine producers’ bottom line.
Additionally, the rise in the U.S. dollar could hurt exporters and pressure the revenue and profit margins of Corporate America, which may also hurt many companies’ ability to borrow or pay back debt.
Volatility in commodity prices could also lead to downgrades for many companies, especially those with below investment-grade ratings. For instance, the recent volatility in oil prices have weighed on the outlook of many small shale-oil producers. [Junk Bond ETFs: Weighing Value Against Default Risks]
Meanwhile, the rising liquidity risks would also damage more speculative bonds. Without enough buyers in the markets, sellers could see prices plunge even further during a steep sell-off. [Some Bond ETFs May Be Providing The Illusion Of Liquidity]
For more information on the speculative-grade debt market, visit our junk bonds category.
Max Chen contributed to this article.