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.”
[related_stories]Earlier this year when the markets were gripped by uncertainty over a possible U.S. recession, junk bond yields surged to over 10% and the spread to Treasuries expanded to 9 percentage points, which reflected the growing premium on speculative-grade debt and investors’ willingness to ride out volatile periods with higher yields to cushion against potential defaults.
However, as uncertainty dissipated and the markets rallied, the spread between junk and Treasury notes has narrowed to 5.2 percentage points. In contrast, the average high-yield bond spread over the past decade is 6.45 percentage points.
Some observers are concerned that junk bond traders may be betting on a so-called Goldilocks economy.
“Good enough is the only thing that works right now for high yield,” Gene Tannuzzo, senior fixed-income portfolio manager at Columbia Threadneedle Investments, told the WSJ. “If you have too-good growth, the Fed will hike. If growth is not good, that’s bad for the economy.”
SEE MORE: Junk Bond ETFs to Diminish Default Energy Producer Risk
Nevertheless, there are those that believe junk bonds may continue to plod along, especially with high valuations in other markets, greater global stability, a rebound in the energy market and the expansion of easy monetary policies around the world.
For more information on the speculative-grade debt market, visit our junk bonds category.
iShares iBoxx $ High Yield Corporate Bond ETF