Traders are piling $11.5 trillion into riskier and riskier bonds - and BofA warns we're in 'uncharted territory'

Business Insider | Jul 15, 2019, 07.30PM IST

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David Rogers/Getty Images

  • Central bank policies are leading more and more investors into riskier parts of fixed income and driving yields lower.
  • An increasingly large section of the high yield or junk bond market has become negatively yielding, meaning investors are effectively paying to hold the security.
  • "Essentially, global bond investors are willing to accept record high interest rate risk for record low compensation," according to a Bank of America note.
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Investors are rushing into fixed income in the search for returns, further driving yields down in a market that is already displaying a high number of negatively yielding bonds.

Fixed income investors are being forced into riskier assets in the junk end of the bond spectrum as the push for yield continues to push investment grade and sovereign returns lower. It's a sign that credit market investors are trying to work out where they can lose the least money in an $11.5 trillion market.

"Essentially the global bond investors are willing to accept record high interest rate risk for record low compensation," a Bank of America note said last week. The bank said last month that credit markets had entered "uncharted territory."

Last week, the US Federal Reserve signaled that it may cut rates, with the market expecting a cut of 25 basis points (0.25%) as soon as this month. That dovishness would come at a time when yields are already low. Lower rates would push those yields even lower, and with stocks hovering near record highs, investors have few choices in the hunt for returns.

"The danger now is that the markets are creating a 'self-reinforcing' feed-back loop which is leading the central bankers rather than the other way round," Jefferies analysts, led by Sean Darby, said in a report.

The European Central Bank could be set to follow suit despite already being at the lower end of the rates scale.

As a result, investors are taking bets on the high-yield space, a growing part of the market, where companies with lower credit ratings traditionally provide higher returns but with greater risk. However, the inflows have driven yields in the corporate high-yield market lower and in some cases negative, a rare turn of events.

Demand from investors looking for risk-averse assets are further driving down yields, especially given that many developed market's sovereign bonds are negatively yielding including Germany, Switzerland, and Japan while US Treasuries are at 2%.

Although the vast majority of the junk bond market remains positive in yield terms, the rush from investors to stay invested is driving yields down further. The ICE Bank of America Merrill Lynch euro high-yield index for BB-rated (junk) corporates is 1.9% - down from 3.6% in January, as reported in the Wall Street Journal.

While as the below chart indicates the amount of negatively yielding bonds is steadily increasing in the euro area.

 Total amount outstanding of EUR index eligible bonds with negative yields

iBoxx, Goldman Sachs Global Investment Research

Outstanding Euro index bonds with negative yields

There are about 14 companies with junk bonds worth more than €3 billion ($3.38 billion) that are trading with negative yields, according to Bank of America.

In short, it looks like we could see more negative and lower yields in the future with fixed income investors forced to move to into a corporate sector with companies whose credit metrics are deemed to be weak by ratings agencies.

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