• 478 days Will The ECB Continue To Hike Rates?
  • 478 days Forbes: Aramco Remains Largest Company In The Middle East
  • 480 days Caltech Scientists Succesfully Beam Back Solar Power From Space
  • 880 days Could Crypto Overtake Traditional Investment?
  • 885 days Americans Still Quitting Jobs At Record Pace
  • 887 days FinTech Startups Tapping VC Money for ‘Immigrant Banking’
  • 890 days Is The Dollar Too Strong?
  • 890 days Big Tech Disappoints Investors on Earnings Calls
  • 891 days Fear And Celebration On Twitter as Musk Takes The Reins
  • 893 days China Is Quietly Trying To Distance Itself From Russia
  • 893 days Tech and Internet Giants’ Earnings In Focus After Netflix’s Stinker
  • 897 days Crypto Investors Won Big In 2021
  • 897 days The ‘Metaverse’ Economy Could be Worth $13 Trillion By 2030
  • 898 days Food Prices Are Skyrocketing As Putin’s War Persists
  • 900 days Pentagon Resignations Illustrate Our ‘Commercial’ Defense Dilemma
  • 901 days US Banks Shrug off Nearly $15 Billion In Russian Write-Offs
  • 904 days Cannabis Stocks in Holding Pattern Despite Positive Momentum
  • 905 days Is Musk A Bastion Of Free Speech Or Will His Absolutist Stance Backfire?
  • 905 days Two ETFs That Could Hedge Against Extreme Market Volatility
  • 907 days Are NFTs About To Take Over Gaming?
  1. Home
  2. Markets
  3. Other

Credit Markets Point To Rising Default Rates

Yield vs. Safety Of Principal

If an investor was given the opportunity to invest in two nearly identical bonds with one bond paying 2% per year and the other paying 6% per year, logic says most would choose to invest in the higher-yielding bond. In the real world, the bond paying 6% also comes with a higher risk of default. Therefore, when investors start to become more concerned about the economy and rising bond default rates, they tend to gravitate toward lower-yielding and safer bond ETFs, such as IEF, relative to higher yielding alternatives, such as JNK. The chart below shows the performance of JNK relative to IEF. The chart reflects a bias toward return of principal over yield.

High Yield Bonds versus Intermediate Treasuries

Some cracks have started to appear in the credit markets in 2016. From CNBC:

The default rate for high-yield bonds has risen to the highest level in six years, and a top bond analyst sees more bad news ahead for investors in so-called junk bonds....Defaults are only likely to increase over the rest of the year, predicts Diane Vazza, S&P's head of global fixed income research.

The concepts illustrated on the chart below are described in this video clip.

High Yield Bonds versus Long-term Treasuries


Potential Problems In The Oil Patch

Longer-term, if the economy flipped into a recession, the bulk of the defaults could come from the energy sector. From Bloomberg:

Wall Street's biggest banks need to set aside more cash to cover losses as low oil prices take their toll, according to Moody's Investors Service. Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. would need an additional $9 billion to cover souring oil and gas loans in the worst-case scenario, the ratings firm said Thursday in a report.


Increased Stress In China's Bond Market

When U.S. stocks sold off early in 2016, one of the market's principal concerns was the health of China's economy. Those concerns could resurface in the coming months. From Bloomberg:

Chinese companies canceled more than double the amount of bond offerings in March compared with a year earlier, as mounting defaults increased financing costs...The surge in scrapped offerings reflects investors' growing concern about default risks amid the worst slowdown in a quarter century.

As China looks to shift to a more internally driven consumer economy, it is possible some companies will not survive the transition. From Bloomberg:

China's top corporate bond underwriter said defaults will increase this year, casting a cloud over the market after record offerings in the first quarter helped refinance debt..."There will probably be many credit events caused by liquidity problems," said Huang Ling at the Beijing-based firm, which Bloomberg-compiled data show underwrote the most corporate bonds excluding notes regulated by the central bank in the first three months. "Some external events may trigger withdrawal of lending by financial institutions."

 

Back to homepage

Leave a comment

Leave a comment