Bond investors are taking on greater risks for subpar profits…
Today’s chart tells that story. It shows the difference (or “risk premium”) between the yield on BB-rated bonds and the yield on “risk-free” U.S. Treasurys…
BB bonds sit just below investment-grade and are considered “junk.” That means they come with greater risk. When the difference between BB and the risk-free rate shrinks, it tells us that investors are overlooking risk in hopes of bigger profits.
That gap is at 2% today. That’s the lowest it’s been since 2007, just before the global financial crisis.
When risk becomes apparent again in the markets, the gap will widen. Then, junk bonds will suffer… just like they did in 2009. Back then, during the crisis, investors fled as risk grew in the markets. BB bonds fell more than 25%.
With the economy slowing again, debt levels rising, and bond downgrades picking up… reaching for this extra 2% in the high-yield debt markets is likely to prove costly.
– Houston Molnar
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