Dividend-News

Why High Yield Bonds Could Surge Again

Published Wed, 23 Aug 2017 13:18:53 -0400 on Seeking Alpha

The conventional wisdom about junk bonds' steep decline in 2014 and 2015 is that it is the result of the crash in oil. Indeed, lower oil prices caused a spike in oil-related defaults throughout 2015 and 2016, and both (HYG) and (JNK) seem to have anticipated this with their steep price declines that made the "taper tantrum" of 2013 look quaint:
However, this narrative only tells part of the story. A lesser known dynamic was actually a major contributor to the sell-off, and this history is important to remember because the opposite may soon happen, which could boost high yield bonds significantly.
In July 2015, the Volcker rule went into effect, which limited non-market-making holding of corporate bonds by banks. That, in turn, limited demand for junk bonds.
As simple economics tell us, when demand declines and supply remains constant, prices must decline. Zooming into mid-2015, when the oil slide had already reached its apex, we see an acceleration in high yield price declines.

This was happening even at a time when high yield defaults were taking a breather:

Again, conventional wisdom tells us that a rising Federal funds rate target caused that price slide-but we're now seeing a much more aggressive increase in the Federal funds rate without a decline in high yield prices; in fact, the spread between Treasuries and high yield has tightened significantly.

Note also that the spread between the two began rising sharply in... Read more