Bloomberg News

Junk-Bond Volatility Gains in Split With Stocks: Credit Markets

February 21, 2013

Junk-Bond Volatility Gains in Split With Stocks

Price swings in junk bonds are widening, diverging from stocks that are the least volatile in more than five years as concern mounts that the eight-month rally in the debt is coming to an end. Photographer: Chris Ratcliffe/Bloomberg

Price swings in junk bonds are widening, diverging from stocks that are the least volatile in more than five years as concern mounts that the eight-month rally in the debt is coming to an end.

A measure of 30-day volatility in relative yields of U.S. speculative-grade corporate bonds almost doubled to 20 last week from a record-low of 10.5 at the end of December, according to data compiled by Bloomberg. That compares with a 32 percent decline this year in the VIX index, a benchmark for expected stock-market volatility, to 12.3 on Feb. 19, the lowest since April 2007.

Wider price swings and waning demand has suppressed junk- bond sales as investors, earning yields near last month’s unprecedented low of 6.4 percent, brace for the potential of rising interest rates that can erode the value of the securities. Federal Reserve minutes released yesterday showed policy makers divided over Chairman Ben S. Bernanke’s bond- buying program that is holding down interest-rate benchmarks.

“You do have some catalysts for volatility in credit that may be a little less dramatic for equities,” said Stephen Antczak, a credit strategist at Citigroup Inc. in New York. “The sensitivity to rising interest rates has a very big impact in total returns in credit.”

Issuance Cools

Speculative-grade borrowers sold 34 percent less debt in the U.S. in the two weeks ended Feb. 15 compared with the previous two weeks, Bloomberg data show.

Junk bonds, which gained 11.7 percent in the eight months ended Jan. 31, are up 0.2 percent this month, the lowest return since losing 1.2 percent in May, Bank of America Merrill Lynch index data show. The performance is showing how unstable the market is becoming at current prices, said Oleg Melentyev, a credit strategist at the bank.

The average junk-bond price has declined 1 cent from the high of 105.9 cents on the dollar reached Jan. 25, Bank of America Merrill Lynch index data show. The continued gains needed to maintain demand for junk bonds “would imply pushing the market valuations further beyond any reasonable levels, thus undoing the very reason for being aggressive in buying risk at these levels,” New York-based Melentyev wrote in a Feb. 8 report. That’s “an unstable combination indeed,” he said.

Credit Gauges

Elsewhere in credit markets, Clear Channel (CCMO:US) Communications Inc. plans to sell $500 million of bonds to help repay a term loan maturing next year. The market for corporate borrowing through short-term IOUs contracted to the lowest level of 2013.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, rose for a second day, climbing 0.7 basis point to a mid-price of 88.2 basis points as of 11:16 a.m. in New York, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, increased 4.1 to 115.1.

Credit swaps typically rise as investor confidence deteriorates and fall as it improves. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bonds of New York-based Morgan Stanley are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 7.2 percent of the volume of trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Clear Channel

The biggest financial brokerage raised $4.5 billion yesterday in its second benchmark-size corporate bond deal this year. Its $2.5 billion of 3.75 percent, 10-year securities climbed 0.4 cent from the issue price to 100 cents on the dollar at 11:09 a.m. in New York, Trace data show.

Clear Channel, the radio and billboard company controlled by Bain Capital Partners LLC and Thomas H. Lee Partners LP after a 2008 buyout, intends to issue so-called priority guarantee notes due 2021 that are “fully and unconditionally” backed by the parent company and all “existing and future wholly-owned domestic restricted subsidiaries,” San Antonio-based Clear Channel said today in a statement.

Proceeds from the bond sale will be used to help pay off the $847 million of loans outstanding under its term loan A facility maturing in July 2014, the company said. Clear Channel has more than $10 billion of debt maturing in 2016, according to data compiled by Bloomberg.

Commercial Paper

The seasonally adjusted amount of U.S. commercial paper fell $22.4 billion to $1.063 trillion outstanding in the week ended yesterday, the fifth straight drop, the Federal Reserve said today on its website. That’s the longest stretch of declines since the period ended Oct. 24 and the least since the market touched $1.058 trillion Dec. 19.

Corporations sell commercial paper, typically maturing in 270 days or less, to fund everyday activities such as rent and salaries.

The measure of swings in relative yields of U.S. speculative-grade corporate bonds averaged 20 in the 30 days ended Feb. 8, up from 10.5 on Dec. 31, according to Barclays Plc index data compiled by Bloomberg. The volatility gauge declined to 16 basis points on Feb. 20, the data show.

The Chicago Board Options Exchange Volatility Index, or VIX (VIX), a benchmark for expected stock-market volatility, plunged 35 percent in the two days ended Jan. 2, to 14.7, as U.S. legislators averted tax increases that risked pushing the nation back into a recession. It continued falling as the Standard & Poor’s 500 Index posted its best start to a year since 1997.

Funds Pulled

“Volatility in credit has indeed been somewhat higher than in equities on a relative basis,” Bank of America’s Melentyev said in an e-mail.

Yields on the dollar-denominated notes have increased 12 basis points to 6.53 percent yesterday since reaching the record low on Jan. 25 as concern mounted that the debt will lose value when U.S. Treasuries rise. The Standard & Poor’s 500 Index rose 0.6 percent during the same period.

Investors yanked $1.4 billion from U.S. high-yield bond funds in the first week of February as Treasury yields rose from record lows to the highest levels in 10 months, eroding the debt’s value, according to data compiled by Royal Bank of Scotland Group Plc and Bloomberg.

Greater Sensitivity

That follows the $20.9 billion of deposits into the funds last year as the Fed held benchmark borrowing rates at about zero in an attempt to galvanize an economy still recovering from the credit crisis. Investors pumped $37 billion into equity funds in January, the most since 2004, estimates from the Washington-based Investment Company Institute show.

“The higher quality of high-yield is now super-sensitive to interest rates,” said Matt Duch, who helps manage $12 billion in assets under management at Calvert Investments Inc. “Often your road map is past events, and I don’t think we have much to go on with high-yield right now.”

Average modified duration on the $452.2 billion of BB rated bonds in a Bank of America Merrill Lynch index rose to an average 5.4 years Jan. 6, the highest since 2007. Duration is a gauge of debt’s sensitivity to increasing interest rates.

Investors from Loomis Sayles & Co.’s Dan Fuss to Oaktree Capital Management LP’s Howard Marks have said prices on junk bonds are too high.

Fuss, whose Loomis Sayles Bond Fund beat 98 percent of its peers in the past three years, said last month that the debt is as “overbought as I’ve ever seen it,” while Oaktree’s Marks told clients in a January memo that “this is a time for caution.”

Fed Debate

Several Federal Reserve policy makers said last month that the central bank should be ready to vary the pace of their $85 billion in monthly bond purchases, according to the minutes released yesterday. That showed policy makers were divided about the strategy behind Bernanke’s program of buying bonds until there is “substantial” improvement in a U.S. labor market.

The officials “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved,” according to the minutes of the Federal Open Market Committee’s Jan. 29-30 meeting released yesterday in Washington.

Borrowers sold $5 billion of junk bonds last week, the lowest weekly issuance of the year, because of “volatility in the secondary market and waning investor demand, evidenced by back-to-back mutual fund outflows,” JPMorgan credit strategists led by Peter Acciavatti wrote in a Feb. 15 report.

The $16.5 billion of issuance in the two weeks ended Feb. 15 comes after $22.2 billion of the debt sales in the previous two weeks, Bloomberg data show.

“High-yield bonds will remain vulnerable to a sharp increase in Treasury yields,” the strategists said in the note.

To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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