Insanity: Now Even Junk Bonds Have Negative Yields

Think about this: a junk bond is basically debt issued by a company with financials so risky that analysts expect there’s a good chance the company won’t pay its debts.

Hell, the company might not even be in business by the time the debt matures.

And yet, despite these substantial risks, investors are willing to loan money to these companies… at NEGATIVE rates of return.

Seriously?? You take all that risk and then GUARANTEE that you’ll lose money.

In other words, as John Rubino recently noted, investors are now extrapolating falling interest rates into the future and playing junk bonds for the capital gains they’ll generate when their future borrowing costs go down. This is one of those sentiment shifts that financial historians will single out for special attention when sifting through the rubble of the coming crash.

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Japan Is About To Sell Its First Ever Junk Bond... With A 1% Coupon

While corporate bond yields have been plumbing ever lower lows in the yield-starved "New Normal", prompting even the world's largest bond fund Pimco to warn that this is the riskiest credit market ever, Japan is about to deliver the proverbial "hold my beer" moment to the entire world. 

Aiful, the consumer lender which almost went bankrupt a decade ago, is preparing to sell Japan’s first ever yen-denominated "high yield" - and in this case we use the term very, very loosely - in the public markets, showing how desperate for yield local investors are, and how much risk they are willing to take in exchange for virtually no return, as negative interest rates have now become the new normal.

What is most remarkable about the bond sale in the country where the 10Y yield has been trading mostly in negative territory for over half a decade, is that the 18 month yen junk bond is set to price on Friday with a coupon of, wait for it, 1%.

Another unique aspect of the upcoming issuance is that it is taking place in the first place. As Bloomberg notes, the junk bond offering will be historic for Japan's bond market, where companies haven’t felt compelled to sell below investment grade notes as they’ve traditionally had close ties with banks, who tend to be more forgiving than bondholders in tough times.

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Connecticut Capital Hartford Downgraded To Junk By S&P

One week ago, Illinois passed its three year-overdue budget in hopes of avoiding a downgrade to junk status, however in an unexpected twist, Moody's said that it may still downgrade the near-insolvent state, regardless of the so-called budget "deal." In fact, a downgrade of Illinois may come at any moment, making it the first U.S. state whose bond ratings tip into junk, although as of yesterday, credit rating agencies said they were still reviewing the state's newly enacted budget and tax package. The most likely outcome is, unfortunately for Illinois, adverse: "I think Moody's has been pretty clear that they view the state's political dysfunction combined with continued unaddressed long-term liabilities, and unfavorable baseline revenue performance as casting some degree of skepticism on the state's ability to manage out of the very fragile financial situation they are in," said John Humphrey, co-head of credit research at Gurtin Municipal Bond Management.

And yet, while Illinois squirms in the agony of the unknown, another municipality that as recently as a month ago was rumored to be looking at a bankruptcy filing, the state capital of Connecticut, Hartford, no longer has to dread the unknown: on Tuesday afternoon, S&P pulled off the band-aid, and downgraded the city's bond rating by two notches to BB from BBB-, also known as junk, citing "growing liquidity pressures" and "weaker market access prospects", while keeping the city's General Obligation bonds on Creditwatch negative meaning more downgrades are likely imminent.

"The downgrade to 'BB' reflects our opinion of very weak diminished liquidity, including uncertain access to external liquidity and very weak management conditions as multiple city officials have publicly indicated they are actively considering bankruptcy," said S&P Global Ratings credit analyst Victor Medeiros. Hartford has engaged an outside law firm with expertise in financial restructuring. Officials also mentioned that the city would initiate discussions with bondholders for concessions to implement a debt restructuring if it didn't receive the necessary support in the state's 2019 biennial budget.

S&P also said that Hartford may be downgraded again if the state passage of a budget is significantly delayed, or if the city were not to receive sufficient support in a timely manner that would enable it to manage liquidity and allow it to meet obligations in a timely manner.

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Why Junk Bonds Will Sink Stocks

“Some very critical things are hidden.”

After the white-knuckle sell-off of global equities that was finally punctuated by a rally late last week, everyone wants to know: Was this the bottom for stocks? And now Moody’s weighs in with an unwelcome warning.

If you want to know where equities are going, look at junk bonds, it says. Specifically, look at the spread in yield between junk bonds and Treasuries. That spread has been widening sharply. And look at the Expected Default Frequency (EDF), a measure of the probability that a company will default over the next 12 months. It has been soaring.

They do that when big problems are festering: The Financial Crisis was already in full swing before the yield spread and the EDF reached today’s levels!

And so, John Lonski, chief economist at Moody’s Capital Markets Research, has a dose of reality for stock-market bottom fishers:

For now, it’s hard to imagine why the equity market will steady if the US high-yield bond spread remains wider than 800 basis points [8 percentage points]. Taken together, the highest average EDF metric of US/Canadian non-investment-grade companies of the current recovery and its steepest three-month upturn since March 2009 favor an onerous high-yield bond spread of roughly 850 basis points.

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