High yield bonds saw their first significant spread widening in a very long time during the month of July. Headline pressure is now starting to feel more common place, as most well respected newspapers are regularly reporting about the potential for a problem in the high yield market. Junk bonds had continued their unabated rise in price and fall in yield until July, but now that a limitless fear is in the system we are thinking about what might be a catalyst to trigger a more significant and painful (for many investors) sell of in corporate high yield debt.
As last week's FT and WSJ regularly pointed out, there seems to be more than just a 'growing concern'. It seems that this 'growing concern' has crossed over into the 'growing fear' category, a distinction that I'm sure no one can articulate. What is easily deciphered, though, is the outflows from junk bond funds - $1.48 B weekly through Thursday - a signal that could cause retail investors to rush for the panic button.
A few weeks ago, I brought up the potential for an issue related to HY ETF and Mutual Fund redemptions. Once selling pressure starts, it will be difficult to contain. Recognizing this, the Fed has started discussing behind the scenes the possibility of exit fees, which of course would very much change the nature and tone of the market. I briefly discussed the liquidity mismatch between what retail investors expect from these vehicles and what is real in the underlying securities. The underlying securities can quickly become less liquid, something that we've seen before. Once that occurs, and selling pressure builds, bid/ask will certainly widen and the HY problem will be exacerbated. He liquidity concerns have been well documented, but less thoroughly reported (perhaps they have been suppressed). Earlier this year the IMF put out a special stability report which pointed to this as becoming a potential systemic event.
We will watch this closely, as we do with all other signals of stress in the HY market. Please feel free to reach out if you'd like to discuss this in further detail.
Enjoy the rainy Sunday,
Richard Travia
Director of Research
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