Investors have started to move away from riskier corporate bonds in the US, with the amount of debt trading at difficult levels doubling since the beginning of the year.
The value of junk bonds trading at 70 cents on the dollar or less, seen as a sign of distress and a warning that a company may struggle to pay debts, has risen to $27 billion from about $14 billion. in late 2021, according to the FT. calculations based on a widely observed index run by Ice Data Services.
The increase reflects a more aggressive Federal Reserve, which raised interest rates for the first time in March and is expected to do so again on Wednesday, the start of a series of forecast rate hikes aimed at fighting US inflation.
The central bank’s pivot also comes along with the war in Ukraine and slowing global growth, clouding the outlook for more indebted companies that may struggle to refinance their loans at higher interest rates.
Marty Fridson, chief investment officer at Lehmann Livian Fridson Advisors, said that while the amount of debt trading at difficult levels has remained low, “it is starting to rise and I expect it to continue to rise. That is significant.
Further monetary tightening by the Fed will push more debt into the distress zone, he added.
The buildup of outstanding distressed debt comes after the worst month for the US high-yield bond market since the coronavirus pandemic-triggered sell-off in March 2020, with an Ice Data Services index falling 3.6 percent in April.
Another measure of distress, the share of debt trading with a yield of 10 percentage points or more above equivalent US government bonds, has also risen, led by consumer and communications companies, according to data from UBS.
Retail technology firm Diebold Nixdorf’s bonds due 2024 fell sharply in April, lifting their yield from about 10 percent earlier that month to 27 percent on Tuesday.
The yield on drugstore chain Rite Aid’s $850 million bond due 2026 has been rising throughout the year, hitting about 13 percent on Tuesday, up from 7.3 percent at the end of 2021.
Some investors remain optimistic about the risks ahead, pointing out that many lower-rated companies have seized the opportunity to raise cash, extending the maturity of their debt and making them less dependent on new money.
However, UBS analyst Matt Mish noted that the number of companies facing high borrowing costs rises sharply for bonds trading above a 10 percent total return. More than 8 percent of the US high-yield bond market is now above this level.
“The weakness is widening,” he said. “He tells you that, at the margin, this is not just a rate issue, it’s also a credit issue. There aren’t many companies that can finance themselves north of 10 percent for a sustained period of time.”