The junk bond market, one of the biggest beneficiaries of easy money, has screeched to a halt.
No US high yield bonds were offered between November 30 and January 10, according to Dealogic. December marked the first month since the 2008 crisis without any junk bonds being issued, the research firm said.
The reversal of fortunes underscores how quickly sentiment can change in financial markets, especially in the riskiest pockets of Wall Street.
“The stock market and oil really drive the junk bond market. They were a double-barreled depressant in December,” said Mark Howard, senior multi asset specialist at BNP Paribas.
The energy sector accounts for about 15% of the US high-yield market, making the junk bond market particularly sensitive to sharp swings in oil prices. The 2014-2016 oil crash sparked dozens of oil bankruptcies.
The silence of the junk bond market marks a sharp slowdown from last December, when 36 companies tapped the junk bond market to raise nearly $18 billion, according to Dealogic.
The good news is that financial markets and oil prices have been on the upswing since Christmas Eve. People are less worried, for now at least, about a recession and the US-China trade war. That could allow for a reopening of the junk bond market.
‘Starting to crack open’
A subsidiary of Targa Resources (TRGP), an oil and natural gas pipeline company, successfully priced a high-yield offering on Thursday. In another positive sign, Targa was able to raise $1.5 billion, twice as much as the Houston-based company originally sought. Sanjay Lad, director of investor relations at Targa, told CNN Business the deal was upsized because of “very strong investor demand.”
It marks the first US junk bond issuance since late November.
“It’s starting to crack open,” said Howard.
This year, US high yield bond funds posted their best start in a decade, according to UBS.
Still, the boom-to-bust in junk bonds serves as another reminder of the role of easy money on financial markets.
Unbelievably low interest rates from global central banks forced investors to scour for returns elsewhere. Vast sums of money were poured into high-yield debt, allowing even some companies with shoddy balance sheets to borrow at reasonable rates.
But that easy money has begun to slowly fade away, with the Federal Reserve simultaneously raising interest rates and trimming its towering balance sheet.
At the same time, Wall Street is on high alert for signs of a recession. A downturn would cause trouble for some companies that reside in the junk bond market.
Not surprisingly, investors backed away from that risky market late last year. Money has flown out of high-yield bond funds in 12 of the past 13 weeks, according to Bank of America Merrill Lynch.
“There is concern that the earnings cycle has peaked. The trade war is not a great help,” said Mike Ning, chief investment officer at PhaseCapital, a boutique investment manager.
Prolonged shutdown could spark trouble
Nervous investors have similarly retreated from another risky corner of the debt market: leveraged loans. These distressed loans had been a favorite investment for years but concerns about higher borrowing costs and slowing growth have changed the risk-reward calculus.
Private-equity giant KKR (KKR) on Wednesday revealed that it has slashed its overweight exposure to leveraged loans to “zero.”
“Given the disclocations of late, we want a little more flexibility,” Henry McVey, KKR’s head of global macro & asset allocation, wrote in a report titled “The Game Has Changed.”
The fear is when the economic cycle ends, these highly leveraged companies will have trouble refinancing their debt. That could lead to a wave of bankruptcies.
“The market was sharply constrained in the fourth quarter. If we saw a prolonged period, you would have companies that would start to have challenges,” said Howard.
Record-high corporate debt
Consider that US nonfinancial companies rated by Moody’s were sitting on $5.7 trillion of debt as of the end of June 2018.
The ratio of nonfinancial corporate debt to GDP has never been higher going back to records that began in 1947, according to the Office of Financial Research, a Treasury Department bureau created after the 2008 financial crisis.
Even if a recession strikes soon, most companies aren’t facing imminent deadlines to pay back debt.
Many CFOs took advantage of easy money to lock in low rates for extended periods. And record-high corporate profits, boosted by the corporate tax rate, have given companies lots of ammo to repay debt.
Most companies have “low refinancing risk” in 2019, according to a Moody’s Investors Service report published on Thursday.
“When the markets get bumpy, high-yield borrowers can sit on their hands and wait,” Howard said.
That’s good because December showed they could be waiting a while.