Junk Bond ETFs Reflect Rising Credit Risks

Yield premiums on speculative-grade debt and junk bond exchange traded funds are steadily rising, reflecting increased default concerns ahead of the Federal Reserve’s expected interest rate normalization.

Looking at the two largest junk bond ETFs, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) has a 6.62% 30-day SEC yield and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) has a 6.92% 30-day SEC yield.

Meanwhile, the BofA Merrill Lynch US High Yield Master II Effective Yield was hovering around 7.92%. In contrast, yields on benchmark 10-year Treasuries were at 2.25% Thursday.

The widening credit spread, or percentage point difference in yields between junk debt and investment-grade bonds, reveals potential concerns for the overall creditworthiness of the private sector since the deterioration of Corporate America’s ability to service debt will likely come first from junk-rated issuers, reports Gavin Jackson for the Financial Times.

With yields rising, companies will have a harder time paying back debt, which could lead to higher defaults.

While junk bonds were typically better off during a rising rate environment, speculative-grade debt may experience greater volatility this time around. Historically, higher-yielding junk bonds helped provide a bigger cushion to absorb the negative effects of higher rates, and the riskier debt tends to do better in an expanding economy where the central bank would feel it safe to raise rates.