Bonds: Total Market
Bond yields had been rising quickly in the US. The rise seemed to come out of nowhere for American investors, but most analysts said the quick jump in ten-year yields was due to a possible policy change by the BOJ to a less accommodative stance. However, the BOJ announced today that it would make only very minor changes and would remain highly loose in its monetary approach. The bank said it would not join other global central bank’s in tightening policy, and would leave rates ultra low for an extended period.
FINSUM: This is good news for bond investors, as Japanese tightening was interpreted as a major threat. This should help keep US yields looking attractive versus global yields, which will in turn keep them lower.
Investors may need to be very worried about stagnant bond yields. After many weeks of pause, bond yields finally look set to move higher. The ten-year Treasury is approaching 3% and as the good market mood and good economic news continues, it seems there could a surge higher in yields. European yields have also been moving sideways for some time. Improving trade relationships, great earnings, and good economic data mean that the bond market may react all at once in the near-term.
FINSUM: This is an interesting argument—bond yields have been quite stagnant despite good news, and they may ultimately react all at once. Seems plausible right now.
Barron’s has put out an interesting article outlining a key correlation in the muni market. We thought it was worth some coverage. A new study out of the University of Illinois has found that muni bond yields tend to lose when local newspapers shut down. Local media often keep local government spending in check and work as a balance on corruption and mismanagement. A multi-year study of the muni market found that yields tended to rise when these papers shut down. The authors summarize “The loss of monitoring that results from newspaper closures is associated with increased government inefficiencies, including higher likelihoods of costly advance refundings and negotiated issues, and higher government wages, employees, and tax revenues”.
FINSUM: This makes perfect sense to us. The problem is that local newspapers have a bleak future at the moment, so the hopes of them serving as a watchdog in the future looks highly unlikely.
There have been a lot of fears about the junk bond market both over the last few years and in recent months. Many worry what a rising rate period would mean for the sector. However, the bigger worry might actually be a recession. Bank of America Merrill Lynch has recently put out a report analyzing the sector, and they highlight a potentially big worry. As many know, over the last decade, companies have gorged on BBB rated bonds (the lowest rung of investment grade), issuing trillions worth. However, the big risk is that in a recession, default rates will surge, profits will fall, and many of those bonds will be downgraded into junk status. When that occurs, many investments funds will be obligated to sell them because of mandates, which could cause a massive exodus and big losses.
FINSUM: The giant BBB market, which has been the superstar of the high yield sector since the Crisis, seems like it might be poised for a serious rough patch come the next recession.
US Treasury bonds got walloped yesterday. Yields on the ten-year fell over 10 basis points following weeks of relative calm. The big move happened in the early afternoon yesterday, and sent ETFs sharply lower. The jump in yields was not contained to the 10-year either, as 20-years and 2-years rose as well. The big question is why the sharp move occurred. Analysts are saying it was actually overseas influences that drove the losses. In particular, the Bank of Japan announced a policy change that would send rates higher, which spilled over to the US. Further, some better news on the trade war front might have sent some money out of Treasuries after a flight to quality in previous weeks.
FINSUM: This is a really sharp move for it to have been from overseas alone, as these kind of big jumps usually move in reverse. It is hard to draw any conclusions, but it may indicate there are bigger losses to come.
There is a new big asset class getting very popular on Wall Street. You may think it is some new esoteric structured credit or volatility product. But guess what, it is just about the oldest product in the world—business lending, or “direct-lending” as it is being called. It has been increasingly apparent on the fringes that big Wall Street players, like Goldman Sachs, have recently taken an interest in direct lending. Now, the whole Street is getting in on the action. Major private shops like KKR and others have started direct lending funds, and the area has returned handsomely, up over 20% this year. The idea of the funds is to lend to businesses and whose credit excludes them from the usual channels.
FINSUM: These funds seem likely to do well until a recession or period of deleveraging occurs, at which time they are likely to see high levels of defaults.