Debt in the Two Largest Economies
When several large state-owned companies in China unexpectedly defaulted on their debts earlier this year, the government seemed determined to send a clear and unified message: it was time to get rid of zombie companies.
But since then, China’s signals have become increasingly contradictory and as a result bond market pricing suggests investors see the smallest chance in seven years that many firms will be allowed to go bankrupt.
…The change of tone between April and August helped fuel the bond rally, leaving the risk premium of one-year AA rated commercial debt over Chinese treasuries, a measure of the expected risk of default, at its narrowest since 2009.
The spread had nearly doubled in April to 180 basis points when investors thought the government was signalling a readiness to let more companies fail.
Drawn by higher yields than on safer bonds and lower valuations than on stocks, portfolio managers and individuals alike have poured money into junk bonds this year. In 2016, more than a net $6.4 billion had flowed into high-yield mutual funds through the end of August, according to data from Thomson Reuters Lipper. Over the prior three years, $47.7 billion flowed out of the funds.
The tide of money has pushed up prices and returns, attracting additional funds from investors. In 2016, the iShares iBoxx High Yield Corporate Bond fund has returned 12%, beating the 7.8% total return by the S&P 500, according to FactSet.
…“When spreads get very tight as they are now, you’re not getting paid as much for taking on credit risk,” said Kathleen Gaffney, who manages the Eaton Vance Multisector Income Fund. “That means your bond becomes much more interest-rate sensitive.”