- Spread has narrowed 43 basis points since end of September
- Pimco sees opportunities in cable firms, healthcare, banking
The extra yield investors demand to hold U.S. junk bonds instead of Treasuries is heading for its biggest quarterly decline since 2013 and Pacific Investment Management Co. says it sees buying opportunities.
The premium on an index of high-yield debt over Treasuries shrank to 655 basis points Wednesday, a decline of 43 basis points since the end of September. The spread had widened by 183 basis points in the third quarter, the most in four years. The yield on the index is 8.2 percent, compared with 1.6 percent for a similar gauge of Treasuries.
“The outlook for the high-yield market, particularly in the U.S., has become more positive,” Andrew Jessop, a high-yield fund manager, and Anna Dragesic, head of credit product management for Europe, wrote in a report on Pimco’s website. “The economic expansion should continue to support a low default environment, outside of higher risk credits in energy- and commodity-related sectors.”
Benchmark U.S. 10-year note yields rose one basis point, or 0.01 percentage point, to 2.19 percent as of 6:05 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.25 percent security due in November 2025 fell 1/8, or $1.25 per $1,000 face amount, to 100 1/2.
Treasuries have handed investors a loss of 0.5 percent this quarter, according to the Bloomberg U.S. Treasury Bond Index. The Bloomberg USD High Yield Corporate Bond Index has returned 1.5 percent. Junk bonds are high-yield, high-risk debt securities that are rated below BBB- by Standard & Poor’s and Baa3 by Moody’s Investors Service.
Yields from 6 percent to 8 percent make U.S. junk bonds a compelling alternative to stocks, and the sector has historically provided positive returns at times of increasing Treasury yields, according to Pimco.
In September and again in October, Pimco said credit markets were attractive. The firm is finding “numerous opportunities” in sectors including cable companies, health care and banking, Jessop, who is based in Newport Beach, California, and London-based Dragesic wrote in the note.
North American high-yield bonds have some potential to see spreads over their benchmarks contract next year, JPMorgan Chase & Co analysts led by Stephen Dulake in London wrote in a research note this week.
Price swings in the high-yield market have intensified with the Federal Reserve poised to raise interest rates this month and as concern lingers over the impact of a Chinese slowdown on global growth and slumping commodity prices.
Fed Chair Janet Yellen said Wednesday waiting too long to raise rates may hurt the economy. The odds of liftoff at the central bank’s Dec. 15-16 meeting at 74 percent, futures data compiled by Bloomberg show. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase, compared with the current range of zero to 0.25 percent.
Junk-rated bonds in the U.S. are heading for their first annual loss since 2008, according to data compiled by Bank of America Merrill Lynch, amid a rout in raw materials that’s pressured companies such as Chesapeake Energy Corp. and ArcelorMittal. The percentage of junk bonds trading at distressed levels is the highest since the markets were recovering from the financial crisis, according to Standard & Poor’s.
“It might seem an odd time to make a case for high-yield debt,” Pimco’s Jessop and Dragesic wrote. “In our view, any continued spread widening or market volatility should provide attractive entry points for investors.”