Market Extra: Junk Bonds Are Off To Best Start To Year Since 2009, As Soft Landing Hopes Take Hold

Junk bond prices are surging.

So, what’s behind the jump?

Investors of corporate bonds rated below investment-grade, also known as “junk” debt, are starting to believe the that the Federal Reserve’s newfound go-slow approach to monetary policy normalization could help forestall a U.S. recession, which could ripple through financial markets, potentially increasing the likelihood that companies with the greatest and riskiest debt may not be able to fulfill their debt obligations.

Against the backdrop of a Fed that appears to be more dovish, or accommodative, high-yield corporate bonds are now off to the best start to a year in a decade, following a selloff in the last three months of 2018 that saw spreads between junk debt and comparable government paper widen to by the most in about two years.

“High-yield performance is saying the Fed will engineer a soft landing in the economy, and suppress volatility and defaults,” John Pattullo, co-head of strategic fixed-income for Janus Henderson Investors, told MarketWatch.

The rally in junk corporate debt has pushed yields for such bonds lower, and prices higher, compressing the yield premium investors pay over so-called risk-free Treasurys TMUBMUSD10Y, -0.35% Known as the credit spread, this premium has narrowed to 3.64 percentage points to its recent gap of 5.44 percentage points on Jan. 3, based on benchmark indexes provided by ICE Data Services. Bond yields fall as prices rise.

Credit spreads, however, have yet to recover all their lost ground, and still remain around 40 basis points, or 0.40 percent point, away from their September lows.

Still, the sharp tightening of credit spreads has helped junk bonds to achieve a total return, which includes the returns from both appreciating prices in the underlying bonds and fixed-interest payments, of 8.6% year-to-date through April 12, marking the investment’s best start to the year since 2009, according to CreditSights.

Exchange-traded funds focused on high-yield corporate bonds have drawn strong interest from investors, even as stock-market mutual funds and ETFs have struggled to attract new money. The SPDR Bloomberg Barclays High Yield Bond ETF JNK, -0.22% and the iShares iBoxx $ High Yield Corporate Bond ETF HYG, -0.24% have attracted $5.7 billion of inflows in 2019. This year, JNK is up 8.1%, and HYG is up nearly 7.6%.

Those ETF gains, however, pale in comparison to the strong run in the stocks, with the S&P 500 SPX, -0.23% up more than 15% in 2019.

Opinion: The junk bond market has good things to say about the stock market

The gains in junk debt come after the high-yield market’s torrid performance last year left such investors down 2.3%, amid fears that indebted firms wouldn’t be able to handle the central bank’s four rate increases in 2018, as the economy buckled under the prospect of slower global growth.

The fortunes of junk-bond investors swiftly turned when the Fed signaled it would hold back on further rate increase in January meeting and reaffirmed that policy stance in March.

Yet as high-yield corporate bonds rally, more fretful investors have called for caution. With spreads near multiyear lows, market participants aren’t sure how much more high-yield credit spreads can narrow when the U.S. economy’s expansion has grown long in the tooth — bearish investors have echoed that notion of stocks as well.

“It’s just not the time to be reaching for yield,” said Margaret Steinbach, an investment specialist at Capital Group.

See: IMF worries financial conditions could change abruptly

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