Interest Rate Roundup

Friday, August 11, 2006

They don't call 'em junk bonds for nothing...

If ever there's been a time to worry about junk bonds (also called "high yield" bonds by those in polite circles), it's now. Over the past few years, there's been a virtual orgy of buying in high risk paper. Buyers snapped up subprime mortgage bonds, higher risk corporate debt, anything that yielded more than Treasuries. Risk? Never heard of it.

All that buying drove the yield spread, or difference, between high risk bonds and Treasuries to extremely low levels. But the times, they are a' changing. Risk aversion is ticking up along with defaults, and there's the potential for some real losses in the next several months, if history counts for anything. A Bloomberg story said the following:

"Corporate defaults jumped and bonds with ratings below investment grade performed worse than Treasuries the previous four times the U.S. central bank ended a cycle of rate increases, according to data compiled by Merrill Lynch & Co. Junk bonds fell an average 5.12 percent in 2000, the last time the Fed stopped boosting borrowing costs, Merrill data show."

The story went on to say that past "spread blowouts" ranged from 49 basis points in 1995 to a whopping 263 bps in 1989. Consider yourself warned.


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