2012-02-06

Disaster in the making: junk bond sales surge; Europeans borrow in U.S. dollars

Record global sales of junk bonds
Junk bond issuance totalled a record $19.6bn last week, including a sizeable chunk of debt that European companies sold in the US, according to Dealogic, the data tracker.
“Lingering concerns about Europe and the strong US rally have pushed many issuers into the US high-yield market,” analysts at Barclays Capital said in a research note.
Credit is tight in Europe, so business is turning to the U.S. credit market where junk bond is near its highs. If, a big if, these firms have substantial cash flow, they are getting good prices for their debt. However, this debt could increase by 20% if the U.S. dollar rallies to parity. The economic environment would be terrible and a lower euro would only mitigate some export losses during the contraction. For investors, there's nothing to like here because this is junk debt that will collapse in price during a slowdown.

Below is a chart of iShares iBoxx $ High Yield Corporate Bond (HYG) and SPDR Barclays Capital High Yield (JNK). The volume at the bottom is for HYG. Investors have been piling into these funds well after they've recovered, chasing yield as Bernanke holds rates low. It's a great investment as long as there's no instability in the markets—a bad bet in my opinion.

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