The junk bond market is going through an eye-opening drought. Not one company under investment grade has issued a bond since November, the longest spell of this kind in more than two decades. Investors are worried over the economy and market volatility, which has basically shut down any new issuance. It has now been 41 days since a junk bond sale, the longest period since 1995. December was the first month since 2008 without a junk bond sale.
FINSUM: When credit starts to get ugly, investors would be wise to pay attention. The question is whether this is just a short-term hiatus or a sign of worse things to come.
The credit market taught investors a very good lesson in the Crisis (not that many of them were paid attention to). One of those lessons was that the first signs of weakness in the market should be taken seriously, as they can be indicative of a pending meltdown. This occurred in 2007 before the cataclysm in 2008. It appears to be happening again now, as both US and European credit marks are showing some fault lines. For instance, the downgrade of GE is seen as a sign of weakness very similar to what occurred with Ford and GM in 2005.
FINSUM: There has been an extraordinary credit boom since the Crisis and there are bound to be consequences. The question is what the extent of those consequences will be. The market is starting to feel a bit like musical chairs.
One of the best indicators of stock market performance is actually in bonds. Because they trade based on fundamentals, high yield bonds tend to be strong leading indicators of stock performance. With markets swinging all over the place, now might be a good time to see what junk bonds are doing. The answer is that the sector looks to be in good shape, with spreads holding steady and no real sign of concern.
FINSUM: Junk is probably not going to really worry until we get very near, or into an inverted yield curve, as a recession would be rough on the high yield market.
Italy looks like it is in bad shape. It is openly defying the EU’s budget rules by running an excessive deficit, and what’s worse, it looks likely to be downgraded to junk status by ratings agencies. Moody’s already downgraded the country to Baa3, its lowest investment grade rating and just one rung above junk status. Yields have been swinging wildly on the country’s bonds as a result.
FINSUM: We are quite worried about the implications if Italy gets downgraded to junk, as it could mean lots of funds need to sell the bonds because of their mandates. What kind of sell-off could that spark?
Yesterday, the ratings agency Moody’s downgraded the city of Chicago to junk status, a move which could potentially trigger $2.2 bn of new claims and impair the city’s ability to turn around its finances. The city was downgraded after a court ruling which limited both the city and the state of Illinois’ ability to handle underfunded pension plans. Chicago suffers from a large pension deficit. New mayor Rahm Emanuel criticized the move by Moody’s, saying that it did not take into account the progress the city had made nor its growing economy. Holders of the city’s municipal debt will not be forced to sell because S&P and Fitch still rate the city as investment grade. Nonetheless, the article says that the downward revision, which also comes with a negative outlook, will exacerbate the city’s financial position. Chicago is the third largest city in the US.
FINSUM: This is a major downgrade and holders of municipal bonds from the city, and from Illinois generally, should take notice. If the city gets downgraded by the other agencies it could have a major problem on its hands because of forced selling by some large holders.
Source: Financial Times