The increased sensitivity to perceived changes (or not) in monetary policy could likely signal that the extended period of easy borrowing conditions and high demand for speculative-grade debt may be coming to a close, according to a new report from Standard & Poor’s Global Fixed Income Research.
For nearly 12 months, U.S. speculative-grade corporations have been enjoying record-low borrowing costs. This has largely resulted from the lack of meaningful returns in other debt markets, particularly U.S. Treasuries, which saw record-low yields during the summer of 2012.
“On the flip side, investors’ hunt for yield has led to a substantial increase in the amount of risk in the corporate debt markets recently, evidenced by the ultra-low yields, record-high issuance levels, a resurgence of collateralized debt issuance, and relaxed lending conditions,” said Diane Vazza, head of Standard & Poor’s Global Fixed Income Research. “These trends are not just limited to bonds–they also extend into leveraged loans, particularly those with ‘light’ covenants.”
Speculative-grade default rates have remained muted roughly since September 2011, but we expect the default rate to increase to 3.3% by March 31, 2014.
“The default rate could climb higher if yields continue to increase at the pace that they have been during the last 30 days,” said Ms. Vazza. “On the flip side, if the unemployment rate stays high and the Fed decides to continue the QE3 program, investor demand for speculative-grade debt will likely increase from the weak levels we’d seen in the first half of June.” Either way, participants in the market for speculative-grade debt have been very reactive to economic data releases during the last few weeks, most evident through the recent volatility in speculative-grade bond returns.
For details, purchase the full report Credit Trends: The Speculative-Grade Market Appears Poised For A Sell-Off (2105 words)