The Vanishing Junk Bond Buyer

Why prices for below-investment-grade debt are falling fast.

No one wants to catch a falling knife.

That has become a substantial problem in the US$1.3 trillion U.S. junk-bond market. Investors are trying to sell, but almost no one wants to buy.

The result has been a veritable free-fall in many bonds' prices. Even an investment-grade bond can have a hard time finding a buyer if it’s suddenly perceived as problematic.

Case in point: Glencore. Although the commodity group’s stock price bounced back a day after Monday’s carnage, its bonds struggled to stabilize. A billion dollars of its debt maturing in 2022, for example, dropped as much as 3.9 cents Tuesday morning in New York, to 67.1 cents on the dollar. In contrast, its shares rallied the most ever.

Meanwhile, distressed bonds, or those that yield 10 or more percentage points more than benchmark rates, have lost 22.2 percent since the end of June, the most for a quarter since 2008. On Monday alone, bonds of Murray Energy plunged 7.4 percent, Avaya Holdings’ bonds lost 6.3 percent, and Abengoa Finance’s notes dropped 5.6 percent, according to Bank of America Merrill Lynch index data.

The broader high-yield bond market has lost value for four consecutive months for the first time since 1994.

This kind of selloff would normally indicate the approach of a floor and an inevitable rebound, but there’s no clear end in sight. Real credit weakness is justifying some investor concerns, as is a looming interest rate increase by the Federal Reserve for the first time since 2006.

The two biggest high-yield bond exchange-traded funds (ETFs) have received $849.7 million of redemptions in the past week, according to data compiled by Bloomberg. Franklin Resources, one of the biggest holders of energy-related distressed debt, has also faced client withdrawals in recent months after some of its funds underperformed their peers. So have a number of credit hedge funds, such as Saba Capital Management and Claren Road Asset Management.

While plenty of big debt-investment managers have cash on hand, they have no clear reason to deploy it until they see evidence that prices are leveling off.

Eventually the knife hits the floor. This one appears to have a way to go.

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