Junk bonds in US show signs of cracking as investors pull cash

WASHINGTON (BLOOMBERG) - Investors pulled US$2.56 billion (S$3.44 billion) from U.S. junk-bond funds in the past week, the second largest outflow this year, as cracks appear in one of the few fixed-income asset classes to withstand the global bond rout.

The two-month jump in government bond yields worldwide is starting to catch up with speculative-grade company debt. The pullback is slowing what had been a record pace of issuance, with sales of the securities poised for the slowest week this year.

"There are a number of reasons to be cautious," Michael Contopoulos, head of high-yield and leveraged-loan strategy at Bank of America Corp. in New York, said via telephone. "The low global yields and low volatility that helped the asset class earlier in the year are disappearing, and fundamentals in the asset class aren't very strong."

With the Federal Reserve getting closer to raising interest rates for the first time since 2006, borrowing costs in the junk bond market have risen to a five-month high. Speculative-grade companies also face low earnings, with negligible growth in the past two quarters, even after stripping out energy companies plagued by falling oil prices, according to Bank of America.

Speculative-grade borrowers have issued US$1.83 billion of debt this week, a pace that would make it the slowest period this year, according to data compiled by Bloomberg. About US$209.6 billion of the securities have been sold in 2015, the least since 2012.

Treasury 10-year yields approached 2.5 per cent for the first time since October on Wednesday as the global bond rout extended losses and raised interest rates.

The average yield on U.S. speculative grade debt has risen more than 30 basis points this month to 6.71 per cent, the highest since February, according to Bank of America Merrill Lynch Indexes.

Still, junk bonds were spared some of the turmoil seen in other debt markets this year. The extra compensation investors demand to hold the securities instead of government bonds is at 4.62 percentage points, down from as high 5.42 percentage points in January.

With the Fed still holding its interest-rate benchmark near zero and the European Central Bank continuing its unprecedented efforts to boost that region's economy, some investors see few alternatives to get yield.

Junk bonds have gained 3.2 per cent this year, compared with a 0.52 per cent loss in investment-grade notes.

The securities may bounce back, with Citigroup Inc. boosting its 2015 forecast for gains to 5.6 per cent from 4.5 per cent.

That may bode well for companies such as Charter Communications Inc., which plans to raise funds in the junk market to back its US$55 billion deal to buy Time Warner Cable Inc.

"In historical terms high-yield performance has been uninspiring, but relative to other asset classes it has been very good," Citigroup strategist Stephen Antczak wrote in a note to clients.