Retail junk-bond investors fight the Fed in pursuit of yield

[NEW YORK] Retail junk-bond investors may well be willing to fight the Fed for the next few weeks.

The US corporate high-yield bond market notched its second straight weekly inflow for the period ended Apr 6, according to Refinitiv Lipper, implying that retail investors are once again buying after 11 weeks of yanking cash from funds that buy the debt.

Spreads have narrowed 0.77 percentage point since mid-March as demand has picked up. It is hard to argue that junk-bond valuations are cheap, according to strategists at Barclays, but this has historically been a good month for the debt, and retail investors along with others may keep buying now that yields have risen.

Speculative-grade notes have generated positive total returns in every April since 2005, according to data compiled by Bloomberg. Since 2000, the median total return for the month has been 1.3 per cent, second only to December, Barclays strategists Bradley Rogoff and Jeff Darfus said in a note dated Friday (Apr 8).

And while there are ample risks for the securities as the Federal Reserve lifts interest rates again as soon as next month, demand from investors should be enough to support the securities for the next few weeks, the strategists said.

"We think spreads will likely trade fairly rangebound, with support from technical factors in the near term before medium-term risks cause them to drift wider," the strategists wrote.

Retail investors have historically bought during April, or at least refrained from net selling: There has not been a retail outflow for the bonds since 2005, the Barclays strategists said.

Individual investors account for more than a fifth of the high-yield buyer base, representing a significant constituency.

Another positive for the bonds comes in the form of coupon payments. There is about US$8 billion coming due to investors in April from securities in the index, making it the second-highest month for these payments, behind only February.

Some investors getting those payments may choose to put money to work back in junk bonds, Barclays said, noting that yields are relatively high, at 6.3 per cent, which could be enough for investors that have target yield levels.

Companies are still generating strong earnings, and defaults should stay low in the near term, said Nichole Hammond, senior portfolio manager at Angel Oak Capital Advisors.

"But we expect periods of volatility as inflation pressure remains and the Fed navigates a tightening cycle," Hammond said.

Inflation pressure could be intense for some high-yield companies, strategists at banks including Citigroup and Bank of America Corp have noted.

Industries including food, transport, and travel could face particular pressure because they have above average leverage and below average margins, according to a Bank of America analysis on Friday.

But these potentially troubled sectors only represent about 18 per cent of the market, strategists Oleg Melentyev and Eric Yu wrote.

Spreads on high yield bonds averaged 3.34 percentage points more than Treasuries on Thursday, according to Bloomberg index data. That is close to the tightest level for those spreads between 2010 and 2020, before Covid, which was 3.03 percentage points, the Barclays strategists wrote, adding that current levels are "quite rich".

Following a 4-week rally for US high-grade spreads, some Wall Street strategists are cautious about credit moving forward.

"The sweet spot for overseas inflows into US IG credit may soon turn sour," Citigroup strategists led by Daniel Sorid wrote Friday.

US leveraged-loan prices have staged a rebound amid hawkish statements from Federal Reserve officials, which has boosted demand for the floating-rate debt.

But there are risks that could lead to downgrades of weaker credits into the CCC tier, which current prices are not reflecting, Barclays strategists Brad Rogoff and Jeff Darfus wrote in a note Friday. BLOOMBERG