Investors have pulled away from speculative-grade debt and bond-related exchange traded funds, pushing up yields on junk bonds.
The U.S. high-yield market is producing yields of about 7.5%, reports Patti Domm for CNBC.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) has a 6.56% 30-day SEC yield and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) has a 6.68% 30-day SEC yield. Over the past three months, HYG declined 4.5% and JNK decreased 5.3%. Bond prices and yields have an inverse relationship, so a rising yield corresponds with falling prices.
However, Michael Contopoulos, head of high-yield strategy at Bank of America Merrill Lynch, argues that the spreads between junk debt and government bonds are actually too tight and yields on speculative-grade debt are too high.
“I think there’s a huge story in high yield that’s been brewing for some time. Even in the non-commodities sectors of high yield,” Contopoulos told CNBC. “Spreads are too tight. Yields are too rich, and the market is beginning to wake up to the fact that you need to be compensated by more than 500 basis points. That’s about 200 basis points lower than where it was in 2011.”
The BofA Merrill Lynch high-yield index is trading at about 600 basis points higher than government bonds. However, if energy, metals and mining debt is excluded from the high-yield index, the spread is about 80 basis points less. Additionally, if commodity producer debt is excluded, the junk bond index has a yield of 6.7%.
The commodity producers make up a good chunk of the junk bond ETFs. For instance, HYG includes 12.5% energy.
Looking ahead, the Federal Reserve could add more pressure on the junk bond market. Fed Chair Janet Yellen has stated that higher rates are coming this year, and analysts expect more selling as rates go higher.