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Bob Carey
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  High Yield Corporate Bonds Popular With Investors Seeking Income
Posted Under: Bond Market
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View from the Observation Deck

  1. Some recent articles in the financial press have posed the following question: Have high yield corporate bonds ("junk bonds") formed a bubble?
  2. History suggests the answer is no. We believe the concern is more of a byproduct of a potential record-setting issuance pace driven by strong investor demand for yield.
  3. The chart shows the relationship between yield and total return on high yield corporate debt since 1990.
  4. The shaded areas indicate periods where the Federal Reserve was tightening its monetary policy (raising the fed funds target rate) in order to temper economic activity and inflation.
  5. Beginning with 1990, essentially every year that high yield corporate bonds posted a negative total return was either preceded or accompanied by Fed rate hikes.
  6. The 9.6% decline in 1990 followed a 325 basis point increase in the federal funds target rate from 1988-1989 (not shown in chart).
  7. As we speak, the Fed is actually contemplating a third round of quantitative easing (QE3) for the purpose of generating more economic activity. It has stated it is prepared to keep rates low into 2014.
  8. From 1990-2011, the average spread (using year-end data points) between the yield on the Barclays Capital U.S. Corporate High Yield Index and the 10-Year T-Note was 583 basis points.
  9. That same spread at the close of July 2012 was 542 basis points. Historically speaking, high yield corporate bonds are not considered "rich" until the spread hits the 300-350 basis point range.
  10. Lastly, the default rate on U.S. speculative-grade debt stood at 3.3% in July 2012, well below its 4.8% average since 1983, according to Moody's.
Posted on Tuesday, August 28, 2012 @ 2:41 PM • Post Link Print this post Printer Friendly

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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