Junk Debt ‘Bubblelicious,’ Prices Approach Par: Credit Markets

Junk bonds are closing in on par for the second time this year as fixed-income investors bet recent signs of economic weakness won’t be enough to derail corporate profits and the ability of the neediest borrowers to repay debt.

High-yield bonds rose to 98.99 cents on the dollar yesterday after falling as low as 94.47 cents on May 25, according to Bank of America Merrill Lynch index data. In the prior rally, the debt climbed to 99.67 cents on April 30. Prices were last at par in June 2007, just before credit markets began to seize up as losses on subprime mortgages spread.

Investors are pouring money into bond funds at the fastest pace in 15 months as defaults slow. Frontier Communications Corp. and Freescale Semiconductor Inc. led a 3.47 percent return for high-yield bonds in July, the most since September, even as weakening consumer spending and factory orders signal the recovery is losing momentum.

“It’s a little bit bubblelicious,” said Don Ross, who helps oversee $9.5 billion of assets as global strategist for Titanium Asset Management Corp. Except for bond-coupon payments, “you don’t have a lot of upside from here,” he said.

High-yield funds had $2.8 billion of inflows in July, the most since April 2009, and have received $3.6 billion in cash this year, Bank of America Merrill Lynch analysts wrote Aug. 2 in a report. Junk bonds yield 8.492 percent, according to the bank’s U.S. High Yield Master II index.

‘Pretty Interesting’

Investors are putting cash into junk-bond mutual funds as money market funds from companies such as Federated Investors Inc. and JPMorgan Chase & Co. offer yields at or below 0.25 percent, according to data compiled by Bloomberg.

“The average retail customer can’t live on 1 percent and that’s the issue,” said Jon Budish, senior vice president of high yield at Jefferies & Co. in Short Hills, New Jersey. “Until the default rate changes or you get a lot of downgrades, or until the Fed says something different, high-yield seems pretty interesting.”

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 176 basis points, or 1.76 percentage point, Bank of America Merrill Lynch’s Global Broad Market Corporate index shows. Yields averaged 3.705 percent.

The cost of protecting investment-grade corporate debt in the U.S. from default fell to near an almost 12-week low.

The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 0.38 basis point to a mid-price of 99.9 basis points as of 11:38 a.m. in New York, according to Markit Group Ltd.

BP Swaps

Credit-default swaps insuring BP Plc debt for a year dropped below five-year premiums for the first time in two months on speculation the bid to cap the world’s worst accidental oil spill will succeed.

Swaps on BP tumbled after the London-based company said its “static kill” action was a milestone in permanently sealing the Gulf of Mexico well. One-year swaps exceeded five-year contracts by a record 414 basis points on June 16, in a so- called inverted curve, as traders bet the spill could force the company into bankruptcy.

Swaps insuring BP debt for five years dropped 30 basis points to 276, and one-year contracts tumbled 85 to 249, according to data provider CMA. The shorter-dated protection implies a 4 percent likelihood of default, compared with about 16 percent in June.

Consumer Spending

Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of bonds and loans.

First Data Corp. bonds and loans rose after the credit-card processor said in a regulatory filing that it plans to seek permission from lenders to change terms of its loan agreements to help pay down debt.

When high-yield bonds last approached par more than three months ago, the Fed said that “economic activity has continued to strengthen,” according to an April 28 statement. The labor market was “beginning to improve” and officials said growth in household spending has “picked up recently.”

Commerce Department figures released yesterday in Washington showed consumer spending, pending home sales and factory orders were all weaker than projected in June. Household purchases, which account for about 70 percent of the economy, were unchanged from May.

Fed’s Overnight Rate

The Fed has kept its target overnight lending rate at zero to 0.25 percent since December 2008. Futures traders have placed 6.3 percent odds, versus 14.9 percent a month ago, of an increase of at least a quarter percentage point, according to Bloomberg data.

While economic data casts doubt on the recovery, 75.8 percent of companies in the S&P 500 that have reported second- quarter earnings have beaten analysts’ estimates, Bloomberg data show.

“The key question is how you interpret the data, and every day you see widely divergent interpretations,” said Martin Fridson, global credit strategist at BNP Paribas Asset Management in New York. “I don’t see signs of frothiness” in high-yield bonds, said Fridson, who began his career as a corporate debt trader in 1976.

Relative Yields Narrow

Relative yields on speculative-grade bonds have narrowed to 655 basis points from 727 basis points on June 11, Bank of America Merrill Lynch index data show. That spread will tighten to 600 basis points by the end of 2010 and to 500 basis points a year from now, the Bank of America Merrill Lynch analysts wrote.

The average price on euro-denominated junk bonds has jumped 5.9 cents since June 10 to 93.03 cents on the euro, the highest in almost three months, according to Bank of America Merrill Lynch’s Euro High Yield Constrained Index. Prices fell to a 2010 low of 87.1 cents on the euro in June as investors fled riskier assets on mounting concern of a sovereign default in the region.

S&P upgraded 245 junk bonds in the U.S. this year and downgraded 185, Bloomberg data show. Last year it upgraded 121 and lowered 676 during the same period.

The global default rate tumbled to 6.1 percent in June from about 12.1 percent a year earlier, and will slide to 2.4 percent by year-end, according to Moody’s. S&P said Aug. 2 the global default rate was 5.04 percent, down from a high of 9.9 percent in November 2009.

‘Strongest Game’

“Corporate metrics are still about the strongest game in town,” said Titanium’s Ross, who is based in Cleveland. “The fundamentals are significantly better than the last time we were approaching anything near this effervescence.”

Sales of high-yield debt more than doubled in July to $16.67 billion from $7.84 billion in June, Bloomberg data show.

Bank of America Merrill Lynch’s high-yield index has gained 8.7 percent this year. Debt of Frontier, the Stamford, Connecticut-based phone company serving rural markets, returned 6.97 percent in July. Freescale, the Austin, Texas-based chipmaker rose 6.88 during the period.

“It’s very much a supply and demand market,” Budish said. “Right now the demand outstrips the supply greatly.”