The debate that has dominated the early part of 2013 is whether an impending move into equities could undermine the rationale for the bond market investing. But the picture is, at best, mixed, especially in the US junk bond market, where the highest in-flows into high yield bond funds in six months have been reported. Whether that signals a renewed appetite for risk is difficult to judge, but what is clear is that low interest rates are still forcing investors to hunt high and low for decent income.
Yields on the lowest rated US junk bonds, co-called triple-C bonds, have fallen from 11.5 to 8.2 per cent in less than one year. CCC isn't a designation that appears often but it relates to debt that is almost entirely dependent on favourable economic and financial conditions for interest and principle payments to be honoured. In other words, it is some of the riskiest investments available on the market. That must lead to questions over whether such a fall in yield is sustainable, or indeed reflects the US's underlying economic performance, although it is true that the total number of bankruptcies are below their historic average. The most likely explanation is that the delay to the US fiscal cliff has given investors a reason to diversify their holdings of higher grade government debt, which is starting to look overpriced and, in many ways, venturing into higher yield debt has become the substitute for investing in equities.
The european debt market is also mirroring the same pattern of behaviour, with investors snapping up bonds with high coupons faster than companies can issue them, and firms taking the opportunity to lock in historically low spreads to refinance large tranches of debt built up during the credit boom. It is this requirement to refinance that leads some commentators to argue that the high-yield market is not in a fundamental bubble. For example, there is no evidence of a net increase in indebtedness as a direct result of so many bonds being issued and companies are taking the strain off their balance sheets by locking in lower long-term interest rates.
Few debates this year are likely to be as divisive as the 'bonds versus equities' stand-off. Our view is that there is enough support under the bond market to prevent a collapse in prices this year, but when the Federal Reserve starts to raise interest rates, then all bets are off.
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