The good run junk bonds has been having is coming to an end as they are about to register an annual loss for the first time since the start of the financial crisis in 2008.
High yield bonds and their interest payments went down by two percent this year, making this only the fourth time in twenty years that they have posted a total-return loss. This fact is worrying for financial industry as the declines in the junk bond market is often a strong predictor of an impending decline in the economy.
Much of the drop in junk bonds comes after last month’s debt selloff as well as expectations of the Fed raising rates. Additionally, there are signs that the sale of debt has extended beyond just companies hit by the ongoing low price of oil, and now includes the majority of debt with a junk rating. This could potentially threaten planned takeovers and make it difficult for companies to raise funds.
Higher Risk, Bigger Return
Junk bonds typically have a higher yield, above 7 percent, as they are issued by companies in heavy debt with a higher probability of default. Investors tend to stockpile them in boom times when higher rated bonds only pay marginal interest and then sell them as soon as they feel nervous.
That time seems to have come, as defaults are now growing after nearly six years of all-time lows, causing the sales of new bonds to stall, affecting the ability of the companies that have low credit ratings to refinance. The default rate for junk bonds has already increased 0.5 percent to 2.6 percent this year and is expected to go up by at least another two percent next year. This will push it over the last three decade average of 3.8 percent for the first time since 2009.