Junk-Bond Exodus by `Tourists' Seen When Bunds Hit 1%

  • Higher-yielding sovereign debt to test credit appetite
  • Dash for risk in euro debt markets set for reversal: JPMorgan

A decade of ultra-loose monetary policy has created a group of hot-money investors in high-yield bonds -- and these tourists may soon be buying a return-ticket home.

Their line in the sand: the 10-year German government debt trading with a yield of more than 1 percent, according to a monthly poll of investors conducted by Bank of America Corp. A higher German benchmark, which currently offers a 0.74 percent yield, was cited as a top concern for money managers over the next 12 months.

“At these levels ‘tourist’ investors in credit might begin selling corporate bonds and flock back to government debt,” according to strategists led by Barnaby Martin in London. Notes in the BB ratings category in the upper echelons of junk look the most vulnerable, he said in a recent note.

Bonds issued by Europe’s most leveraged companies sold off in the recent global market volatility but have recovered January levels after risk premiums surged to a nine-month high.

The staying power of tourists -- who’ve snapped up the debt to escape negative yields on government obligations and even high-grade credit -- may help to explain the relative resilience of the asset class. But as the European Central Bank starts winding down its bond-purchase program, it may be setting the stage for their exodus.

Even though the ECB itself doesn’t buy speculative-grade debt, 141 billion euros ($174 billion) of corporate bond purchases since June 2016 have crowded out investors like pension funds and insurers from their usual high-grade realm, pushing them further down the risk spectrum into junk bonds.

"In our view, higher rates will drive a reversal of the ‘search-for-yield’ as investors stop using short-duration credit as a cash replacement product,” Matthew Bailey, a credit strategist at JPMorgan Chase & Co. in London, wrote in a recent note.

His team anticipates yield premiums on euro-denominated high-yield bonds will widen by 45 basis points, on average. Investors are currently getting 298 basis points more to hold speculative-grade debt denominated in the single currency relative to government benchmarks, according to Bloomberg Barclays indexes.

— With assistance by Paul Cohen

(Corrects size of ECB holdings in sixth paragraph.)
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