Junk-Bond Selling Frenzy Neutralized as Wall Street Buys

Evidently there was a scare in the U.S. high-yield bond market this past week.

Just don’t ask traders about it. They might have missed it.

While junk-bond funds reported an unprecedented $7.1 billion outflow in the week ended Aug. 6, the debt only lost 0.9 percent. That’s a lot less than the 1.4 percent plunge during the previous record withdrawal, when investors pulled $4.6 billion in the week ended June 5, 2013, Bank of America Merrill Lynch and Lipper data show.

“Prices haven’t dropped all that much,” said Eric Gross, a credit analyst at Barclays Plc in New York. “It’s been nonstop questions of ‘When do we buy back in?’ People are standing and window-shopping for what to buy.”

One possible explanation for why values haven’t declined more is that fund managers are using their cash reserves to meet redemptions, instead of actually selling the debt.

“We’ve had pretty big cash reserves anticipating this selling,” said Marc Gross, a money manager at RS Investments in New York, which oversees $4 billion in high-yield debt. “I think people drained their cash reserves to meet these redemptions and haven’t sold much.”

Holding Cash

Taxable bond funds were holding about $269 billion of cash or cash-like assets at the end of June, equal to about 9.2 percent of their assets, according to Investment Company Institute data. That’s more than three times the amount needed to meet the worst month of outflows.

It’s not surprising junk-bond fund managers might have been accumulating cash given all of the angst about speculative-grade debt. Yields have been near record lows and Federal Reserve Chair Janet Yellen has said she sees signs of froth in the market. Escalating conflicts in Gaza and Ukraine have also hurt appetite for risky securities.

Sentiment has been souring and risk premiums on U.S. high-yield bonds have climbed almost a percentage point since June. The extra yield, or spread, investors demand to own the notes instead of government debt widened to 4.2 percentage points yesterday from 3.35 percentage points on June 23, according to Bank of America Merrill Lynch index data.

Much of that increase has come in recent days, with the spread climbing 0.41 percentage point since July 30.

Dealers Buy

Still, given the mammoth withdrawals, traders are wondering why they haven’t widened more. In addition to the fund managers’ cash-reserves thesis, Wall Street buying may explain part of it. Primary dealers boosted their net junk-bond holdings to $8.2 billion in the week ended July 30, up $3.3 billion from two weeks earlier and the highest level since the period ended Feb. 12, according to the latest Fed data.

So even though some investors are running from this market, for now there seem to be some buyers on the other side of the trade.

Near-zero interest rates from the Fed -- what’s prompted this insatiable appetite for risk -- aren’t ending yet and investors still want yield. Don’t be shocked if the debt starts to rally, erasing this blip from memory.

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