Investors in junk bonds will lose a yield cushion of more than 1.5 percentage points as the Federal Reserve winds down its unprecedented quantitative easing program that’s bolstered credit markets for five years, according to Martin Fridson.
“Tapering has been delayed, but high-yield investors should nevertheless assume that the end of quantitative easing will eventually hurt their returns,” Fridson, chief executive officer of New York-based FridsonVision LLC, a research firm specializing in speculative-grade debt, wrote in a report yesterday.
The central bank said in November 2008 it would buy bonds to ease credit conditions and in September 2012 began the third-round of asset purchases, now totaling $85 billion a month of Treasury and government-agency mortgage-backed securities, to aid economic growth and reduce unemployment. While economists surveyed by Bloomberg had expected it to begin to reduce the program, known as quantitative easing, in mid-September, concern that job-market conditions weren’t improving stayed the Fed’s hand.
Once quantitative easing ends, “the rise in long-term Treasury rates that will almost certainly result will adversely affect the total return of high-yield bonds,” Fridson wrote.
Fridson’s analysis is based on economic forecasts from William Cheney of Manulife Asset Management, whose projections were closest to perfect for gross domestic product and the consumer price index from December 2011 before the latest round of quantitative easing, according to an analysis of economists surveyed by Bloomberg. Cheney’s a good guide, Fridson wrote, because the projection “of a forecaster who hits GDP and CPI on the head is a reasonably reliable indication of what the rate will be if the Fed does not change the game by instituting quantitative easing.”
Cheney forecast the 10-year note would reach 3.4 percent by the end of 2012, about 1.64 percentage points above where it finished the year, which indicates how much QE suppressed interest rates, according to Fridson, who started his career as a corporate debt trader in 1976. That means yields now without QE would be about 4.25 percent, he said.