Pimco Favors U.S. Junk Bonds Over Europe as Issuers Return

  • Corporate borrowing costs are still low, especially in Europe
  • Issuance globally is regaining ground lost earlier in year

Investors looking for greater rewards from high-yield debt should favor the U.S. over Europe as junk bonds regain ground lost earlier in the year, according to Pacific Investment Management Co.

“The overall European high-yield market returns about 4 percent today where the U.S. market yields at around 6.5 percent,” Andrew Jessop, head of global high-yield portfolio management at Pimco, said in an interview in Munich. “Over half of the European market yields below 3 percent and we see limited value in that from a future return perspective.”

Borrowing costs for junk issuers are still low, especially in Europe, where the European Central Bank’s bond-buying program weighs on yields from sovereign bonds and investment-grade corporate debt. Sales in euros and sterling have made September the busiest month for high-yield issuance this year, and are poised to eclipse every September since the 1999 introduction of the single currency. In the U.S., issuance this month is on track to surpass the same period last year, according to data compiled by Bloomberg.

“While we forecast an increase in interest rates in the U.S., we do think it is relatively modest and that is something which certainly the broader high-yield market can absorb,” said Jessop, who helps oversee about $32 billion of dedicated high-yield investments at Newport Beach, California-based Pimco. “If interest rates go up, they do so because the economy is doing better and that certainly will benefit the more speculative names in the high-yield market place, the B to CCC parts of it.”

Sales of high-yield corporate debt are clawing back ground lost earlier in the year when slumping commodity prices and slowing growth in China chilled the market. Global sales of junk bonds are down 17 percent at $319 billion, according to data compiled by Bloomberg.

The ECB’s bond buying is limited to investment-grade corporate bonds. President Mario Draghi on Sept. 8 reiterated that, if warranted, the central bank will use all instruments available in its mandate to return inflation to a level closer to 2 percent. The Bank of England said in August it will begin buying corporate debt in September.

“In Europe maybe there is a sense now that interest rates shouldn’t be going lower as the negative interest-rate environment is playing havoc with pension funds and life-insurance companies,” said Jessop, who started in the high-yield market in 1987. “Every high-yield investor needs to build a degree of cushion for future defaults. While the default rate is still benign, history will repeat itself and investors need to be mindful that they are being adequately compensated.” 

The average yield on speculative-grade euro bonds fell to 3.8 percent on Sept. 7, the lowest since April 2015, according to Bloomberg Barclays Index data. In the U.S., average yields on junk-rated debt are about 6.3 percent.

“In the U.S., the market has moved past the shake-out in the oil exploration and production industry,” Jessop said. “The industry has gone a long way in strengthening balance sheets with equity issuance and none of the few remaining high-yield issuers that haven’t fully restructured yet face an imminent liquidity crisis.”

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