Displaying items by tag: BBB
For many months there has been a great deal of fear about the threat of BBB bonds falling into the “junk” category. The whole fear is based on the idea that as the economy slows, this huge group of companies would get downgraded and there would be forced divestiture, sending bond prices strongly lower. However, the opposite has happened. Over the last few months, BBB bonds done nothing but strengthen. In fact, the spread between BBBs and Treasuries just hit a 52-week low, showing investors renewed faith in what is the largest segment of corporate bonds.
FINSUM: Unsurprisingly, the price growth has led to a bunch of new issuance. It is important to remember that though prices have risen, the risk of a recession and downgrades is still very much there.
For many years Pimco was the undisputed leader in bonds. While that reputation may now be arguable given Bill Gross’ departure, Pimco is still undoubtedly highly respected. Therefore, their warning this week is worrying. The firm says it is shunning corporate bonds because of the big risk of a quick fall in prices. The firm’s CIO, Dan Ivascyn, says “The credit sector has been well behaved but if people begin to really fear recession, we can see underperformance quickly … this is the sector most prone to overshooting on the downside”. Pimco is also worried about Treasuries as they see no further room for a rally and instead are favoring agency MBS.
FINSUM: Total debt has grown hugely and a lot of it is of borderline credit quality, so a real downturn in economic expectations could lead to a lot of selling and downgrades. We tend to agree with Pimco here.
Remember when everyone was really worried about corporate bonds several months ago? A lot of that anxiety faded as yields tumbled. That led companies to once again issue mountains of debt this year. Now, we are circling back towards worries over a recession, and with that progression there is reason to worry about corporate bonds, especially the BBB variety. The big anxiety, as ever is that a whole section of the BBB bonds universe (the lowest rung of investment grade) will get downgraded to junk status in a recession, causing a massive selloff.
FINSUM: So these fears are not new, but the likelihood of a recession appears to be growing. Here is what really worries us—the BBB market is enormous, amounting to $3 tn in the US versus just $1.2 tn for the whole high yield bond market.
Everyone is watching the BBB bond market with a very close eye. The bottom fringe of the investment grade market, it saw an extraordinary jump in issuance over the last few years. Now, with rates rising, it looks very vulnerable. However, all that suspicion hasn’t amounted to much as investors have kept the area afloat. Ratings agencies and the IMF have both warned about the startling growth of BBB issuance, but so far, the sector is holding up.
FINSUM: Don’t be fooled. There is a massive amount of BBB debt and when a recession finally arrives alongside much higher rates, there seems bound to be a reckoning. That said, there are pockets of the market, like utilities credits, that seem like they will hold up better.
Some are very worried a junk bond bear market might be on its way. Not only are rates and yields rising fast, but there has been a huge run up in high yield prices over the years, with a simultaneous surge in bottom rung BBB bonds. However, despite this scary back drop, the market has been doing well and looks set to continue to do so. “The key dynamic in the high-yield market is recession … There’s a possibility of some economic shock that isn’t apparent right now, but you don’t have the classic signs pointing to recession”, says one CIO. High yield’s spread to Treasuries recently touched its lowest point since the Crisis, and in a twist, the lowest rated bonds (CCC) are performing the best this year.
FINSUM: This is quite confounding in many ways, especially considering there have been significant outflows from junk bond funds and investors can get good returns from investment grade.