Junk Bond Bubble in Pictures: Deflation Up Next

-edited

The widely discussed "everything bubble" is, in reality, a corporate junk bond bubble on steroids sponsored by the Fed.

The highest grade AAA corporate bonds yield 2.75%. BBB-rated corporate bonds, just one step above junk, 3.5%. BB-rated bonds yield just 4.28%.

Corporate Bond Spreads

The spread between Prime AAA bonds and lower-medium grade bonds (see chart below) is just 0.77 percentage points.

The spread between BBB lower-medium grade bonds and non-investment grade, speculative BB-rated bonds is just 0.69 percentage points.

The spread between BBB and BB-rated bonds hit six percentage points in the great recession.

Bond Rating Steps

Chart from Wikipedia's Bond Credit Ratings.

Volume of Negative-Yielding Debt Rises Sharply

In the real world, yields would never be negative. In the Central Banks' bubble-blowing world, the Volume of Negative-Yielding Debt Rises Sharply.

  • From a low last October of just under USD 6 trillions the value of the Bloomberg Barclays Global Aggregate Negative-Yielding Debt Index has more than doubled, increasing in value by over USD 7 trillions over the last 8 months to establish an all-time record of USD 13.2 trillions earlier in late June.
  • The current situation is a manifestation of the inability of global financial markets to emerge from the era of ultra-low bond yields that central banks engineered in the wake of the global financial crisis.
  • Non-conventional policies pursued by central banks in recent years have lead neither to a rise in sluggish rates of economic growth nor to an end in the disinflationary trends within the global economy.

Leverage on the Rise

Also, please note a $1 Trillion Powder Keg Threatens the Corporate Bond Market

Levered Up

  • After a decade-long buying spree, many companies have pushed their leverage to levels that are typical of junk-rated borrowers in their sectors.
  • Bloomberg News delved into 50 of the biggest corporate acquisitions over the last five years, and found more than half of the acquiring companies pushed their leverage to levels typical of junk-rated peers. But those companies, which have almost $1 trillion of debt, have been allowed to maintain investment-grade ratings by Moody’s Investors Service and S&P Global Ratings.
  • This M&A-fueled leveraging of corporate balance sheets contributed to a surge in debt rated in the bottom investment-grade tier and now represents almost half of the outstanding market, Bloomberg Barclays index data show.

The above article and chart is from October 11, 2018. The leverage (and bubble) is bigger today.

BBB-Share Keeps Expanding

Wolf Richter explains What Happens When BBB-Rated Companies Try to Dodge a Downgrade to “Junk”.

In the next downturn, many bonds in the BBB-category will transition to junk, and many junk bonds but also some investment-grade bonds – if the past is any guide – will transition to default. Two-notch downgrades are not uncommon: one day you wake up, and your “BBB” investment-grade bond is a “BB+” junk bond.

To avoid a downgrade to junk, companies will try to shore up their balance sheet. This means curtailing or stopping share buybacks and slashing dividends.

This is a process GE went through. After blowing nearly $14 billion on share buybacks in the four years through 2017 to prop up its shares, GE stopped on a dime and transitioned to dismembering itself to pay down debts. The share buybacks stopped cold. Then it slashed its dividends to near-zero. And its shares have plunged.

GE now sports a credit rating of “BBB+” with negative outlook, three notches from junk, after getting hit by a round of two-notch downgrades late last year. Despite having already cut off some major limbs to reduce its debts, GE still has $97 billion in long-term debt. And GE is still trying hard to dodge further downgrades.

Richter's article is from April 9, so again the situation is worse now than as-reported then.

Ultimate Oxymoron Alert

The Wall Street Journal provides the Ultimate Oxymoron Alert: Some ‘High Yield’ Bonds Go Negative

In the latest sign of financial markets going into uncharted territory, more than a dozen junk bonds, which usually carry high yields, now trade in Europe with a negative yield.

It is a stark illustration of how ultraloose monetary policies have turned debt investing into a choice about how to lose the least amount of money.

There are about 14 companies with junk bonds worth more than €3 billion ($3.38 billion) that are trading with negative yields, according to Bank of America Merrill Lynch. They include telecom giant Altice Europe NV and tech-equipment company Nokia Corp.

Everything Bubble

  1. Stocks
  2. Bonds
  3. Consumer Confidence
  4. Buybacks
  5. Faith in Central Banks

The "everything bubble" has at its roots central bank policy of yield suppression.

Central banks made it easy for corporations to borrow money for leverage buyouts, to buy back shares, and for zombie corporations to get enough funding to stay alive.

Investors (speculators actually), especially retiring boomers, are as optimistic as they were in 2007 when they viewed their own house as a retirement vehicle, not a place to live.

Investor Faith

Investor faith in central banks has never been higher.

At the individual level, baby boomers see the stock market is up so they buy a car and have a nice vacation.

Corporations borrow money to buy back their own shares or to make insanely leveraged buyouts.

Hedge funds buy low-yielding junk bonds in belief yields will get even more ridiculous.

Deflation Coming

The Fed is hell bent on producing inflation. The sad part is they do not now how to measure it. Inflation is all around us: In junk bonds, in equities, and in home prices.

The Last Chance for a Good Price Was 7 Years Ago

The Fed re-blew the housing bubble.

Those who fail to spot inflation in the above chart are clueless about inflation.

Bubbles B Goode

"Maybe some day, your name will be in lights, saying Powell cut rates tonight."

Equity Bubble Will Burst

The equity bubble will burst. I can even tell you when.

Unfortunately, my answer is useless: The equity bubble will pop when the junk bond bubble pops.

When is that? I don't know.

Several years ago I thought we were in the 9th-inning. If we we were, then it's the 12th inning now with all eyes on Powell.

But what Powell does now is irrelevant. The bubbles will pop and one rate cut or even four will not make a damn bit of difference.

Another very destructive asset bubble deflationary collapse is baked in cake.

Mike "Mish" Shedlock

Comments (43)
No. 1-18
Maximus_Minimus
Maximus_Minimus

Time to roll out 50, 100, and 1000-year bonds. It's not that it makes any sense, but at this level of lunacy, why not? It will be repaid in convertible pebbles and shells...

Carl_R
Carl_R

Re: "The equity bubble will pop when the junk bond bubble pops."

I would suggest that the equity bubble, the real estate bubble, and the junk bubble will all pop after the crypto bubble. Equities have real value, as they are a share of ownership of a company. Real estate obviously has value as well (well, most real estate). Even junk bonds have value, as they are promise to be paid by a company, a promise that might not be fulfilled, of course. In the end, cryptos are a data file. They aren't backed by anything or anyone. The only value they have is that someone is currently willing to pay for them. Heck, even tulips had value - you could always plant them, and they were pretty.

With cryptos on a recent tear, I don't see a collapse in equities, junk bonds, or real estate happening soon.

Roger_Ramjet
Roger_Ramjet

It's always comforting to see the rating agencies on top of things as always. Oh my stars and garters, what would we do without the great analytical work by Moody's and S&P!

ZZR600
ZZR600

London house prices are cratering, I suspect this indicates a wider UK and international trend

Webej
Webej

There are a number of reasons for investors to buy negative yield bonds:

  1. The capital gains if yields go even more negative
  2. Negative yield is less negative than deposit rates at the bank
  3. There is either no convenient way to keep the money as cash or there are regulatory reasons to put the money in bonds. There are a lot of scenario's in which all of these reasons could blow up in their face.
Sechel
Sechel

Junk bonds act more like equities than fixed income in my book. The economy is strong so there is some rationale for investing in high yield. That said if the Fed is driving down yields it does force investors to reach for yield. Similar but different to quantitative easing. I tend to buy into the theory that low alternative yields more than a strong economy are driving investors into junk

AWC
AWC

Yeah, well, Mish, the junk bond market will likely remain irrational longer than you will remain solvent ;-)

compsult
compsult

Deflation is certain but I think "emergency" MMT (aka helicopter money or HM) can change that in a hurry. One scenario - the Fed (pressured by Trump), cites deflation as a reason to print and gives that $ to the Treasury, who sends it out as checks. The rapid increase in money supply would temporarily arrest the deflation.

In the same way the Fed was encouraged by the outcome of the original QE (to do more rounds of QE), so they would likely be encouraged by the initial "success" of HM. So after the effects of HM1 wear off and deflationary pressures re-emerge, there would be HM2.

You see where all this is going: WeimarBabwe

Chris Stankevitz
Chris Stankevitz

What if the fed launches another round of QE in which they buy stocks and bonds all along the curve? That should keep the can rolling for another decade or three. Will anyone really be surprised if they do that?

Greggg
Greggg

Soon, the latest consumer item will be safes to avoid this problem... but why save a dwindling currency?

Ted R
Ted R

The bubble has already burst in the energy sector.

Heffaklump
Heffaklump

Nothing to fear. Capital destruction already has happened, it only has to come to light.

Sechel
Sechel

hmm. Junk bonds? I thought the elephant in the room was leveraged loans and the CLO market, something I suspect the Fed doesn't even fully monitor.

JonSellers
JonSellers

Deflation is a good thing in all of those sectors as long as your lifestyle isn't dependent on high prices. The majority of especially young Americans would be happy seeing lower housing and equity prices. And none of these things actually effect the provisioning of goods and services, so who cares other than some bankers and stock brokers?

MadDenker
MadDenker

With negative govt. bond yields in Europe, are European corporates also trading with negative yeilds?

Bankster
Bankster

CCC spreads have widened. Once the default rate ticks up, you'll see the Bs and BBs widen as well. Unlike in prior recessions, nearly 40% of the leveraged loan market is rated single B. It used to be closer to 20%. As most of these are covenant light, they won't have covenant defaults, but they will have payment defaults. I think things will start getting ugly in loan land this year.

jonwb
jonwb

I happened to take a look at Moodys (MCO) own debt/equity ratio, and gulped when I saw it at 43x. Can someone please explain how that works, before my head explodes.

AliceSmith
AliceSmith

God, grant me the liquidity to refinance, The courage to pay for a negative yield, And the wisdom to price the difference