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Unwary Yield Hunters Risk Liquidity Trap

High-yield bonds have had a record run. With a cumulative return of more than 150 per cent since 2009, they have beaten stocks in three out of the past six years. But the market is now stumbling, and regulators have highlighted signs of frothiness. With the end of the US Federal Reserve’s low-for-long policy in sight, investors are set for a rough ride. Yields are near record lows and liquidity in secondary markets is declining, making it harder to exit swiftly.

Reducing exposure earlier could be a wise decision. During the recovery, the Fed’s policy response supported investor demand for credit products, allowing US banks and corporates to refinance cheaply. Corporate bonds outstanding have grown to $10tn from $6tn and now represent more than two-thirds of funding to US groups. With 4 per cent growth, unemployment near 6 per cent and signs of rising wages, we are now in the last phase of the easing cycle.

But the end of low-for-long could turn policy makers into victims of their own success. During the past five years, credit markets have attracted less experienced investors who switched from low-yielding Treasury bonds and money market funds to investment-grade and high-yield debt. These inflows could reverse if monetary policy changes direction, just as they did during last year’s “taper tantrum”. Indeed, US high-yield mutual funds and ETFs registered a record $7.1bn of outflows in the week to August 6.

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