High-Grade and Junk Bonds Are Getting Scarier Every Day (JNK)

Prices for investment grade and high-yield corporate debt have rolled over

Bond markets have turned into cataracts of uncertainty, which has both high-grade corporate debt and junk bonds selling off at an ominous rate.

Corporate BondsBond prices for U.S. corporate debt have bounced around all year, but it’s nothing compared with what fixed income is doing now. Indeed, Goldman Sachs says current volatility in the bond market is “unprecedented.”

There are number of factors roiling the bond market. A sense of improvement in some sectors of Europe’s economy is one force pushing for higher inflation. So is the European Central Bank’s trillion-dollar stimulus plan.

Meanwhile, better-than-expected economic data in the U.S. has the bond market worried about a rate hike coming sooner rather than later. And Europe, Japan and China are flooding the markets with liquidity amid stagnant growth.

Taken all together, it has turned a no-brainer of a trade into something more complicated. As Goldman Sachs International’s Vice Vice Chairman Michael Sherwood told CNBC:

“We went from a period where rates were a one-way bet down when the (European Central Bank’s) QE (quantitative easing) program was announced; we had a situation where 30-40 percent of government bonds had negative yields. That is starting to reverse itself a little bit, but it’s too early to tell.”

The selloff in the bond market has yields sitting at levels not seen in some time. The benchmark 10-year Treasury note is back to yields last seen eight months ago — sending yields soaring because of the inverse relationship between bond prices and yields. The German bund, which hit a record low of 0.05% in April, has been routed since then, recently hitting 0.99%.

Prices for benchmark German debt haven’t been this low since September and the way they’re whipping around is fueling concerns about liquidity. Like Treasuries, the market for bunds is wide and deep — or at least it’s supposed to be.

Bonds Slammed Across the Board

The selloff has hit the most popular exchange-traded funds for high-grade corporate debt and junk bonds pretty hard.

The iShares iBoxx Investment Grade Corporate Bond ETF (LQD), the Barclays High Yield Bond SPDR (JNK) and the and iShares iBoxx High-Yield Corporate Bond ETF (HYG) have both rolled over since the end of May.

Partly, that performance is the result of follow-through from the action in Europe, and partly it’s from fear that the Federal Reserve might hike interest rates in the not-too-distant future. It’s no secret that an imminent rate hike will cause a selloff in bonds.

What’s unknown is whether this is merely a passing spasm for the bond market or the beginning of the end for a decades-long bull market. But fears that the Fed will hike rates before year-end are probably overblown.

The labor market is much improved, but wage growth isn’t. Corporate-profit growth has petered out, consumer spending remains soft, and prices show no signs of inflation.

There’s no question that HYG and LQD haven’t been this risky in years, but that’s not a reason to panic. At some point, the bond market will likely settle down and trade on fundamentals again.

Bonds are in for a hard time when rates rise, but we’re not there yet. Besides, the market has been waiting for that moment for a long time. One would hope it has prepared itself for that eventuality in a way that prompts a more orderly selloff than we’ve seen this spring.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/06/junk-bonds-jnk-hyg-lqd/.

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