"IMF Sounds The Alarm Over Junk Bonds"
From ZeroHedge:
Ever since the start of 2018, an odd divergence has emerged in credit
markets, where Investment Grade bonds have seen their spreads leak
progressively wider, hitting levels not seen in 2 years, while the bid
for higher yielding, and much more risky, junk bond debt has been
seemingly relentless, with high yield spreads near all time lows.
To be sure, many reasons have been offered, with Bank of America
suggesting that IG weakness is "due to supply pressures in an
environment of reduced demand that began in March and extended through
last week, plus the Italian situation, which is about systemic risks
running through the global IG financial system." Meanwhile, it believes
the strength in HY is mostly due to the lack of supply of higher
yielding paper.
Whatever the suggested reasons, however, the underlying causes are
two: an environment of artificially low interest rates created by
central banks, and unyielding, pardon the pun, investor euphoria. In
other words: a multi-year credit boom.
And while the Fed's "macroprudential regulation team"
appears to have zero problems with what is going on in the world of junk
bonds, the IMF has sounded the alarm on the troubling developments in
junk bond land in particular, and capital markets in general.
In its The Chart of the Week, the IMF Blog shows the impact of a bad
credit boom - one which the fund defines as followed by slower economic
growth or even a recession - on economic growth in the years that
follow. But first, it ask a basic question: what makes for a bad boom?
The IMF's answer:
it is fueled by excessive optimism among investors. When the economy
is doing well and everybody seems to be making money, some investors
assume that the good times will never end. They take on more risk than they can reasonably expect to handle.
Ok, but how can one tell when risk-taking is getting out of hand?
After all the Fed is notoriously bad at being unable to time just when
to pull the punch bowl away, and instead lurches from one bubble
boom-bust cycle, to another, greater one instead. According to the IMF,
one way to make the distinction is to look at the riskiness of credit
allocation, adding that firms where debt expands faster become
increasingly risky in relation to those with the slowest debt
expansions, posing downside risks to growth down the road. This is
obviously common sense.
The second method is more directly linked to the issue at hand,
namely the glut in junk bonds. Here is the IMF on how to spot euphoric
risk-taking:
Another method is to look at the bond market to see how much of the
money companies and governments are borrowing consists of high-yield
debt, also known as junk bonds. (These are bonds that offer higher
yields to make up for the greater risk of default by the borrower.) The larger the proportion of high-yield debt, the higher the level of risk in the financial system.
Next, in calculating the impact of bad booms on growth, the IMF
looked at data on debt issued by governments and non-financial companies
in 25 advanced economies, and defined a boom as a period of faster-than-normal growth in credit relative to GDP. Finally, it looked at how much of the credit growth consisted of high-yield debt.
And, judging by the current conditions, the IMF found that the world effectively finds itself in just such a "bad boom" phase.
So what then?
The IMF concluded that credit booms marked by a rising share
of junk bonds were followed by lower economic growth over the following
three to four years.
When the high yield share of debt rises by one standard deviation—a statistical measure of how much one number differs from the average in a set of numbers—GDP growth over the next three years is lower by 2 percentage points....
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