Fed Stimulus Is Resuscitating the High-Yield Bond Marke

 

Buyers of junk-rated corporate bonds aren't taking a vacation in August. 

Issuance of U.S.-denominated high-yield bonds has already topped $44 billion this month, Moody's Analytics estimates, setting a record for the typically slow August. That eclipses the previous high of $33 billion from August 2012. 

The surge in issuance is a sign that the Federal Reserve's bond-buying spree has helped resuscitate credit markets in the wake of the coronavirus pandemic, reopening the spigot for some of the riskiest corporate borrowers. 

"The fact that you have the high-yield bond market open is unusual for an economic slump," said John Lonski, chief capital markets economist at Moody's Analytics. He credits the Fed for stabilizing the financial system. 

Since May, the Fed has amassed about $8.7 billion of exchange-traded funds focused on investment-grade and high-yield bonds. Starting in mid-June, it has also purchased $3.5 billion of mostly investment-grade corporate bonds issued by companies including Walmart Inc., Berkshire Hathaway Inc. and Boeing Co., disclosures show. 

The purchases are part of its secondary market bond-buying fund, which it announced in the spring as part of a larger $2.3 trillion economic-rescue package aimed at stabilizing the markets. 

Fed Chairman Jerome Powell said last month that the goal was to "provide credit at times when the market has stopped functioning." 

It is no longer clear the purchases fit that bill: The Federal Reserve paid as much as 121 cents on the dollar on some of its bond purchases in July, data released Monday shows. 

"At these prices, this is not a market screaming, 'We need help from the Fed,'" said Andrew Park, senior policy analyst at Americans for Financial Reform, which advocates for tighter financial rules on Wall Street. 

The Fed previously cut interest rates and said it would tailor its purchases to market conditions and would slow buying as recovered to pre-pandemic levels. The bank's purchases of corporate bonds and exchange-traded bond funds recently slowed to the lowest pace so far since purchases started on May 12, according to analysts at BofA Global Research. 

Even as purchases slow, the Fed's pledge to do whatever it takes to support the economy is helping keep bond markets humming. Earlier this week, packaging company Ball Corp. issued a 10-year bond with a 2.875% coupon -- a record low coupon outside of government-supported deals in the wake of the crisis, according to BofA analysts. 

The effective yield for junk-rated borrowers is now hovering near 5.6%, down from its 2020 high of 11.4% on March 23, when the Fed unveiled its corporate bond-buying program and other interventions. 

The lower borrowing costs are a boon to highly leveraged borrowers owned by private-equity firms, which frequently tap the high-yield bond markets to finance their acquisitions. The second quarter saw one of the highest-ever levels of junk-bond issuance by private-equity-backed companies. 

The firms have also been busy raising debt funds to take advantage of the recovery. In May, Kohlberg Kravis Roberts & Co. said it raised about $4 billion for a fund that will invest in "credit opportunities created by recent market volatility." There are 45 similar North America-focused funds in the market seeking about $58 billion, according to private equity-tracker Preqin. 

Some investors may regret taking on too much risk. Both Moody's Corp. and S&P Global Inc., the two big credit-ratings firms, are predicting the default rate for junk-rated U.S. corporate borrowers will top 12% early next year, which suggests investors should be demanding higher yields to compensate for the additional risk. 

"That has never been seen before and I'm puzzled by that," said Mr. Lonski of Moody's Analytics.