With the size of US junk bond market at $1.2trillion last year, we witnessed a huge outflow of about $60bn from junk rated debt due to rate hikes (resulting weaker investor confidence) and sharply falling oil prices in December 2018.
As investors are calibrating that Federal Reserve might have gone on hold with rate hikes, they have been pulling money out of leveraged loans (in which they invested enormously at the beginning of this year owing to better yields than junk bonds which looked expensive after their prices jumped last year) for 13 consecutive weeks, according to Lipper. For the last three weeks, they have been pouring money into junk – bond funds including $3.86bn of inflow this month that was biggest since July 2016.
However, this surge in junk bond investing have suppressed the risks that already existing leveraged loans pose to financial system. According to BIS, the total of leveraged loans and high yield bonds outstanding in Europe and US has doubled to about $2.65 trillion since the financial crisis.
Risky companies got highly levered in pursuit of higher profit however, they forgot that this would leave them in a vulnerable position and shake them with higher borrowing costs. “Diminished ability of highly levered companies to service high interest costs would worsen their refinancing opportunities” warned analysts at Moody’s Investors Service.
The point of relief in this storm is indecision of Federal Reserve and ECB whether to raise borrowing costs which have made the possibility of crisis remote and also because the rate of defaults among companies is low, at less than 2 percent with S&P Global Ratings and Moody’s Investors Service both forecasting a modest rise to about 2.5 percent this year.
(with inputs from Apra Sharma)