WSJ: Not too tough to figure this one out, it's the same buy inflated assets Risklove trade.
– Today’s Market Forecast –
By Michael Hudson
Bond Conundrum Redux
Investors like to watch the bond market for clues about the economic outlook. If you do that now, you’ll get a headache. Treasury yields are behaving as if a recession is approaching. But in the corner of the bond market that would be hit hardest by a downturn — junk bonds — investors are partying like it’s 1999.
In the Treasury market, bond investors usually expect better returns on long-term notes than on short-term bills, because long-term bonds are exposed to unwelcome inflation over bigger stretches of time. But the bond market has been upside down since July. Three-month Treasury bills yield just over 5%, while the yield on the 10-year Treasury was 4.44% Friday. The “inverted yield curve” could be a harbinger of recessions; investors could be buying long bonds on a hunch the Federal Reserve will have to slash the very short-term federal funds rate — even higher at 5.25% — to boost economic growth.
In the junk-bond world the backdrop is different. Junk, or “high yield,” bonds are issued by the shakiest corporate borrowers who would likely suffer most in a downturn. One might expect these bonds to weaken if the economy risks deteriorating. But junk-bond fans, hungry for investments with even slightly better returns than Treasury bonds, don’t see recession risks. Instead they’ve focused on the currently low rate of junk-bond defaults and have been gobbling up new junk issues, which hit a monthly record in November.
Junk investors aren’t demanding much for their money either. Jack Ablin, chief investment oficer at Harris Private Bank, says junk-bond yields are about 3.4 percentage points above safer 10-year Treasury note yields. That’s paltry compared with the 6.6 percentage-point premium earned when the yield curve — as measured by 10-year notes and the fed-funds rate — has inverted in the past decade, he calculates.
Caution might be in order for junk bonds. But Tom Huggins, an Eaton Vance bond-fund manager, says it still feels “like there’s a fair amount of momentum left in the market.” Treasury yields might not flip for some time either. The Economic Cycle Research Institute’s Lakshman Achuthan notes foreign central banks and other overseas institutions have been big buyers of Treasury bonds, helping to keep Treasury yields exceptionally low. They’re unlikely to change behavior overnight.
Still, it’s a good bet somebody is going to get hurt. The question is: Will it be junk investors bullish on the economy, or economic bears who love safer Treasurys? |
