Credit buyers double down on BBB and high-quality junk bonds

New York

AS THE Federal Reserve moves closer to expanding the money supply, corporate bond investors are snatching up notes and taking more risk - but not too much more.

Prices on the lowest-rated investment-grade bonds are jumping, as are the highest-rated junk bonds. While high-yield investors are still favouring relatively safer securities, those that invest in high-grade are reaching for yield in the riskiest part of that market.

Corporate bonds have been riding high as the Fed signalled a greater willingness to lower interest rates to sustain the economic expansion, giving a green light to investors to look for higher yields. Risk premiums on investment-grade notes have tightened 0.05 percentage point since last Tuesday, while the Federal Open Market Committee was still meeting, while high-yield spreads have narrowed by 0.33 percentage point.

"It's been all buyers. Investors are going down the quality spectrum," said Travis King, head of investment-grade credit at Voya Investment Management. "That means the lower BBBs, the crossovers - stuff that trades wide."

Investors are showing a greater willingness to take on risk and flooding into the asset class, at least up to a point. Many new issues in both investment-grade and high-yield have been oversubscribed by multiple times amid strong demand, and both asset classes saw positive fund flows last week. Exchange-traded funds that track corporate debt have also seen money pour in. But it's a tougher environment for riskier credits. CCC rated bonds, the riskiest tier of high-yield, have underperformed safer BBs and multiple lower-rated borrowers cancelled debt sales last week after being unable to drum up sufficient demand.

While investors are hungry for risk now, some caution that there are still plenty of reasons to be worried about lower-rated bonds. Anne Walsh, chief investment officer of fixed income at Guggenheim Partners, said at a conference last week that plenty of BBB rated bonds are still at risk of being downgraded and investors may have become too confident in companies' ability to pay down debts quickly.

Voya's Mr King says he thinks the rally could continue, especially as more buyers from outside the US step in. More than US$13 trillion of bonds worldwide currently carry negative yields, up from US$8.4 trillion at the beginning of March. US investment-grade bonds, with their average yield of 3.2 per cent, can look particularly attractive relative to local alternatives for investors in Europe and Asia.

The rally has sent the difference in spreads for BBB and BB rated bonds to just 0.57 percentage point, the lowest level since 2007, according to Bloom-berg Barclays index data. And strategists say the market could stay strong in the coming months.

"We ultimately find it hard to argue with the 'don't fight the central bank' sentiment in the short term," Barclays analysts Bradley Rogoff and Shobhit Gupta wrote in a note on Friday. They recommend buying BBB rated bonds of companies like General Motors, Kinder Morgan and Macy's that have seen strong equity gains but more muted debt performance this year. BLOOMBERG