US junk bond default rate set to jump

Fairfax Media

GLOOMY: The US high yield bond default rate will rise to between 14 percent and 16 percent, comparable to the rate during the Great Depression.

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The US high yield bond default rate will rise to between 14 percent and 16 percent, comparable to the rate during the Great Depression, from about 10 percent now, Greg Peters, head of global fixed-income and economic research with Morgan Stanley in New York, said.

High-yield, or speculative grade, bonds have had a stellar six-month rally as investors have gone back into riskier assets after the financial market panic of late last year.

U.S. fixed income markets are currently pricing in the assumption that the U.S. high-yield bond default rate will rise to 16 percent, Peters told the Reuters Investment Outlook Summit in New York, In the depths of December's market panic, the high yield market was pricing in a 70 percent default rate, but investors do not now expect that Armageddon-type scenario now, he said.

Speculative grade bonds' yield spreads over Treasuries have narrowed dramatically, to 1,041 basis points on Friday from extreme wides of more than 2,100 basis points in December, according to aggregate Merrill Lynch data.

For corporate bonds as a whole, the longer term outlook is comparatively robust, he said.

"I think credit will outperform equities and other fixed income instruments not only this year but over the next couple of years," Peters said.

Both government and corporate bonds, however, are vulnerable to inflation fears, stemming from huge government debt issuance to pay for financial rescues. Bond markets are "clearly starting to worry" about the inflation threat and are more concerned about this danger than the Federal Reserve is, he said.

The benchmark U.S. 10-year Treasury note's yield, which moves inversely to its price, rose above 4 percent for the first time since October last week.

The inflation concern among bond investors, not expectations for economic growth, is the catalyst that has driven the U.S. Treasury market yield curve -- or gap of longer maturities' yields over shorter maturities -- to a record wide, he said.

- Reuters