Flu Season for Junk Debt as Oil and Fed Spread Pain, UBS Says

It’s flu season for U.S. high-yield debt, and there’s no handy vaccine for vulnerable issuers, according to UBS Group AG.

The oil rout that drove junk-bond energy debt to the worst returns since the financial crisis has deepened this month, threatening to distribute the pain through the broader speculative corporate-bond market as investor risk appetite diminishes, UBS strategist Matthew Mish said in a client note on Wednesday.

"We are becoming increasingly concerned that contagion will spread within the U.S. high-yield market given the latest decline in commodity prices," Mish wrote. “A further decline, in our view, will make rising correlations and contagion within the broader U.S. high-yield market a virtual certainty as refinancing fears rise for lower-quality high yield."

Oil dropped to the lowest level in almost three months, falling below $40 a barrel Wednesday for the first time since August and pushing a broad measure of global commodities to a 16-year low.

Energy companies, already struggling to address funding needs, will see increased scrutiny from investors as the U.S. Federal Reserve begins to unwind the easy-money policies it adopted after the 2008 credit crisis, according to UBS.

‘Deteriorates Further’

Investors "are reticent to add exposure if they cannot sell before the credit environment deteriorates further," Mish wrote. "This phenomenon is particularly problematic as the Fed has stopped expanding its balance sheet by trillions of dollars and as market participants have increasingly recognized the lack of market liquidity -– particularly for lower-quality credit risk."

That’s when the contagion effect come into play, said Mish, with a broad pullback in risk spreading to non-energy companies.

Issuers "will need to prove market access over the next several quarters," Mish wrote. "Otherwise the market will write them off -– and their bond valuations will fall further as the maturity wall is never far off."

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE