Junk bond issuance is at record highs this year—and thus at the greatest danger should yields start rising.
Companies around the world have issued $254 billion in high-yield debt this year, a number that includes $130.6 billion from the U.S., according to the latest numbers from Dealogic.
Global issuance is up a stunning 53 per cent from the same period in 2012 and has accounted for 9 per cent of the total deals in the debt capital markets space—also a record and fully one-third higher than last year’s pace.
The U.S. issuance has increased 24 per cent over the previous year. Record issuance also has come from the U.K., China, Russia—and debt-plagued Italy, which despite being at the centre of the European sovereign debt crisis has seen $7 billion hit the junk bond market this year, Dealogic said.
(Read More: This Tax Loophole Mistake Saves Companies Billions)
Because junk bonds have a history of trading in tandem with the stock market, it’s not a big surprise to see issuance swell.
The Standard & Poor’s 500 has surged nearly 16 per cent this year, and the high-yield market has followed. The Barclays U.S. Corporate High Yield Index returned 4.75 per cent through April.
But with investors beginning to fear that the Federal Reserve may stage an early exit from its monetary stimulus programs, fears are growing that junk bonds could take a hit.
“On the surface, things look pretty good in the high yield market,” Citigroup analysts said in a report. “Digging a little deeper, however, we see some troubling signs.”
All that supply is beginning to take a toll on the secondary market—where those who buy the bonds from issuers go to trade them—and there are signs that demand is waning.
The two leading exchange-traded funds for junk—the SPDR Barclays High Yield Bond and the iShares iBoxx $ High-Yield Corporate Bond—sustained a combined $660 million in outflows last week, the second-worst of any class after emerging markets, according to IndexUniverse.
Mutual funds saw a similar trend, with $581 million in high-yield redemptions, the worst week since November, according to Thomson Reuters.
(Read More: Fed Throws Junk Bond Lifeline to Weak Companies)
Citi said the monthly total looks like it will be the largest high-yield selling since at least November 2008.
Where the market goes from here is likely dependent on the Fed.
Some Open Market Committee members indicated at the last meeting that a gradual decrease of the central bank’s $85 billion a month in purchases of Treasurys and mortgage-backed securities would be warranted as early as June.
In response, Treasury yields have jumped upwards, and some firms—Goldman Sachs, in particular—are asserting that these could be the early days of the bond bull market’s demise.
(Read More: Goldman: This US Treasury Sell-Off Is for Real)
“We’ve been bullish on high yield since September and will not change our view based on these developments, because we believe the market has overreacted to the Fed’s comments,” Citi said. “They highlight, however, the challenge for the FOMC and the risk of a policy misstep.”
The biggest potential misstep: A move by the Fed that would startle markets, push investors away from riskier bonds and send yield spreads wider.
All that issuance suddenly would find a tougher marketplace, driving up yields and making borrowing for lower-credit companies significantly more expensive from the current yields which slipped below 5 per cent in May.
Citi said the exodus from high-yield has been due to “an expectation of faster liquidity withdrawal from the Fed” and warned that “as this occurs, capital flows are likely to turn negative, in our view, thereby limiting access to funding and maybe even increasing default concerns.”
_By CNBC’s Jeff Cox. Follow him on Twitter at @JeffCoxCNBCcom.
This story was originally published by CNBC.
Business Insider Emails & Alerts
Site highlights each day to your inbox.