In Bond Market Musical Chairs, Be Ready for Bids Halting

It’s hard to blame bond investors for being nervous.

They piled back into benchmark U.S. Treasuries yesterday after a civilian plane got shot down in eastern Ukraine and as Israeli troops entered Gaza. They accelerated withdrawals from the riskiest debt in the past week, yanking $2.3 billion from high-yield bond funds, the biggest outflow since June 2013, according to a Wells Fargo & Co. report.

Wall Street’s largest bond dealers cut their net junk-bond holdings to $4.8 billion in the week ended July 9, the lowest level since the Federal Reserve began reporting the data in April 2013.

While credit still shows signs of froth -- with new funds to buy junk-rated loans popping up left and right -- investors are increasingly anxious about when the market will turn. Their quickness to dump high-risk securities for the safest ones around shows a lack of faith that easy-money policies from central banks around the world are fueling sufficient economic growth to keep this rally going.

Yields on U.S. junk bonds have climbed to 5.9 percent from a record low of 5.69 percent on June 23, according to Bank of America Merrill Lynch index data. The debt has lost 0.46 percent this month, after 10 straight months of gains.

Musical Chairs

Aside from lackluster growth, there’s also concern that markets will unravel as the Fed tries to withdraw its stimulus. Fed Chair Janet Yellen herself has said she sees signs of excessive risk-taking, particularly in the markets for bonds and loans rated below investment grade.

“My nervousness about what is going on in the high-yield market is escalating,” Peter Tchir, head of macro strategy at Brean Capital LLC in New York said in a July 17 e-mailed note. “It is a bit like musical chairs. Everyone walking in a circle pretending not to be eyeing the chair, but scared that when the music stops, they won’t have a chair -- or, in this case, a bid.”

Tchir called for a two-to-three cent drop in junk-bond prices that he said would “drag” investment-grade corporate bonds down, too. Yields on high-grade debt have plunged to within 0.35 percentage point of their all-time low, according to Bank of America Merrill Lynch index data.

Near Zero

Buyers funneled $2.4 billion into investment-grade corporate debt funds, the 30th consecutive week of deposits, the Wells Fargo report shows. Money is flowing in even though analysts predict a rise in benchmark yields by year-end, which would eat into the notes’ returns.

Perhaps it won’t take long for complacency to settle back in, prodding investors back into more speculative securities. After all, it’s paid off to be a buyer in pretty much every selloff since the 2008 crisis, and Yellen has signaled she plans to keep benchmark interest rates near zero for a while.

Or maybe this signals the start of a deeper malaise that will persist for a longer stretch.

Either way, it highlights that debt markets aren’t quite as calm as they may appear.

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