Market

Junk bond social gathering begins to wind down

If Party City’s outcomes this week are something to go by, then it may be time for high-yield bond buyers to name a cab.

Despite being the riskiest a part of the mountain of debt that has been raised lately, high-yield, or “junk”, bonds have held up nicely within the face of unrelenting fairness volatility, tighter financial coverage from the US Federal Reserve, rising inflation, disrupted provide chains and struggle in Europe. That is, till lately.

Party City kicked off every week of disappointing earnings outcomes that helped the junk bond market spring from its slumber. The firm got here below stress within the first quarter from constrained helium provide and hovering costs simply as demand is escalating forward of the US commencement season.

Helium is a big enter price for Party City, and contributed to the corporate’s earlier struggles earlier than the pandemic. Chief govt Bradley Morgan Weston mentioned on its earnings name that it had managed to supply sufficient helium to fulfill its purchasers’ calls for however at an sudden knock to earnings of $2mn. Alongside rising freight and port charges, the extra helium price helped drag earnings detrimental. 

Balloons don’t defy gravity on their very own, and after the disappointing outcomes, neither did Party City’s bonds. The firm’s $750mn bond offered only a yr in the past and maturing in 2026 deflated to simply above 70 cents on the greenback from north of 90 cents on the finish of April.

The bonds weren’t alone to endure, as buyers reassessed the flexibility of high-yield issuers to face up to the strained financial outlook.

Up till the top of April, a broad index of high-yield bonds run by Ice Data Service had misplaced 8 per cent for the yr. But buyers nonetheless felt comparatively assured about credit score danger, the probability that an organization may not pay you again. The index fall was virtually totally pushed by the fast rise in rates of interest.

Notably, the index losses in contrast with a fall within the Nasdaq which reached 30 per cent this week for the yr to this point. That chimes with previous cycles. Bond losses are sometimes lower than these seen in fairness markets when circumstances flip tough as a result of they sit increased up in an organization’s capital construction, extra insulated in chapter.

And investor confidence on credit score danger was proven within the distinction between company bond yields and equal US Treasuries, a selection that successfully strips out the transfer in rates of interest represented by sovereign bonds and offers a clearer indication of buyers’ view of the well being of lower-rated firms. High-yield bond spreads began the yr at 3.10 per cent, inching increased early within the yr earlier than rallying again in March and sitting at 3.5 per cent on April 21.

However, since then, spreads have began to rise, ending April at 3.97 per cent. In the 9 buying and selling days which have adopted, spreads have risen by an extra 0.5 proportion factors, outpacing the sell-off for your complete earlier a part of the yr.

The transfer has been significantly stark for the bottom high quality bonds rated triple C, proper on the backside of a scores ladder that begins at triple A and crosses into high-yield beneath triple B and into double B scores.

Returns on this phase of the market had outperformed increased rated debt earlier this yr as a result of the strong financial outlook helped help the concept that their general well being would enhance over time, decreasing spreads and counteracting the rise in rates of interest.

This month although, triple C returns have fallen beneath the broader market, in a transparent indication that nervousness over rate of interest danger is starting to morph into nervousness over credit score danger.

“It’s been a rough, rough market,” mentioned Matt Eagan, a portfolio supervisor at Loomis Sayles in Boston. “There’s really no place to hide. It’s a turning point in terms of the nature of the credit sell-off.”

Speaking to bond fund managers this week — together with Eagen — it’s clear this isn’t but a breaking level. Confidence within the high-yield market to face up to additional headwinds stays, albeit much less unabashed. As one bond dealer mentioned midweek, this appears like a shopping for alternative. They simply need another person to start out shopping for first.

The Ice Data Service High Yield index stands at 7.5 per cent, a stage it has solely breached on 4 different events previously decade, most lately within the worst of the pandemic induced sell-off and earlier than that through the vitality disaster in 2015 and progress scares that emerged in 2018.

“My base case at the end of the first quarter was that the Fed would be able to execute a soft landing,” mentioned Jeremy Burton at PineBridge. “That’s still my base case but the bear case is increasing in probability.”

joe.rennison@ft.com

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