US High-Yield Bonds: No Room For Complacency

corporative deb fedSome of the Fed's moves to improve corporate financing are still not bearing the expected fruits

Markus Allenspach (Head Fixed Income Research, Julius Baer) | Even though the US Federal Reserve is expected to start buying US high-yield exchange-traded funds anytime soon, investors should remain selective and only hold debt of companies that were profitable prior to the Covid-19 crisis.

The US Federal Reserve is expected to start buying corporate bonds anytime soon. The Fed New York, which is in charge of daily open market operations, announced last week the start of the programme ‘in early May’. There is no room for complacency, however. The Fed will acquire lowest-rated debt only in the form of index-linked products, which is not sufficient to keep ‘zombie companies’ liquid and solvent.

Investors will recall that the Fed is refinancing existing loans to companies only with a debt-to-EBITDA ratio below 6x and new loans with a ratio below 4x. In other words, the Fed is not lending to companies that were over-indebted prior to the Covid-19 crisis. Moody’s, the rating agency, pushes in the same direction. It expects the default rate of US speculative-grade issuers to rise to 13.3% in the next 12 months, up from the current default rate of 5.4%. We maintain our call for Ba/BB rated issuers and warn that the risk of holding the low end of the credit spectrum is still elevated as long as we have no clarity over the pace of the economic recovery.

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