Junk Bond ETF Rally May Be Getting Stretched

Speculative-grade, junk bond exchange traded funds have recovered from the crude oil-induced sell-off and then some, but the asset category may be looking pricey.

Year-to-date, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) gained 12.1% and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) rose 12.9%.

SEE MORE: Junk Bond ETFs Shake-Off Year of Uncertainty

However, the recent performance has pushed down yields – bond prices and yields have an inverse relationship, with the spread on yields of junk bond debt over yields on Treasury debt falling to their lowest level in over a year, reports Corrie Driebusch for the Wall Street Journal.

HYG now shows a 5.42% 30-day SEC yield and JNK comes with a 5.79% 30-day SEC yield.

Some fixed-income traders are growing concerned that the steadily rising prices and lower spreads could diminish the speculative-grade debt market’s ability to generate overall positive returns even as rising interest rates cut down the value on bonds.

As the Federal Reserve eventually hikes interest rates, the crowded junk bond trade could experience greater volatility, which many have warned about, including Janus Capital Group Inc. bond guru Bill Gross.

“When spreads get very tight as they are now, you’re not getting paid as much for taking on credit risk,” Kathleen Gaffney, who manages the Eaton Vance Multisector Income Fund, told the Wall Street Journal. “That means your bond becomes much more interest-rate sensitive.”