The promise of low borrowing costs for longer just doesn't pack the punch it used to.
Last week should have been fantastic for the $1.3 trillion U.S. junk-bond market: The Federal Reserve scaled back its prediction for how quickly it will raise benchmark interest rates, while also expressing confidence in the world's biggest economy. That's almost an ideal world for junk bonds.
And yet investors yanked $1.3 billion from mutual funds that buy the debt last week, and they've pulled $2.9 billion this month, according to data compiled by Wells Fargo & Co. Dollar-denominated high-yield bonds, while rallying some immediately after the Fed statement was released Wednesday, have lost about 1 percent in March after gaining 2.4 percent the month before, Bank of America Merrill Lynch index data show.
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This very same environment—a gradually strengthening economy coupled with near-zero rates—has produced big returns for years. Junk debt has posted average annual gains of 15.6 percent since 2008. Riskier companies ostensibly will be able to keep refinancing their debt at relatively low rates for the foreseeable future while also benefiting from the economic expansion.
But there are a lot of new risks out there that could undermine the value of junk bonds.
Oil prices have plunged 56 percent since their peak last year, pressuring the balance sheets of energy companies that have sold record volumes of speculative-grade debt. Greece is perhaps closer than ever to leaving Europe's shared currency, and China's meteoric growth is slowing significantly.
So it's no surprise that bond traders have been much jumpier this year as the Fed starts preparing its first rate increase in nine years. They tend to have less appetite for risk when the market becomes less predictable.
This is why there have been outflows from high-yield debt markets "in the face of all other factors saying demand should be there," Deutsche Bank AG credit strategists Oleg Melentyev and Daniel Sorid wrote in a March 20 report. "High volatility cuts two ways. It pushes investors towards fixed income in a general sense, and yet it naturally limits how far they would be willing to go to reach for yield."
Implied price swings in U.S. Treasuries have been 41 percent higher this year than last year, according to Bank of America Merrill Lynch's Option Volatility Estimate index. Junk-bond prices have swung almost twice as much this year compared with the same period in 2014, index data show.
The tranquilizing effect of six years of central-bank stimulus is wearing off in the credit markets, leaving in its wake some fickle junk-bond buyers.
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