High-Yield Bonds Could Cause Next Financial Crisis
There’s a big problem no one seems to be paying attention to. It could trigger the next financial crisis. If you are not watching it, you could be making a very big mistake.
What’s this big threat? High-yield bonds.
Before going into any details, understand fully what they are. The term “high-yield bond” is slightly deceiving; don’t just think they only offer high returns.
These are the bonds that are issued by companies that have high chances of defaulting on their debts. These bonds also have another name: junk bonds.
They come with a lot of risk. Let’s say, if you are earning a yield of one percent on government bonds, these bonds would have a yield of over five percent.
Now, some perspective. Since the last financial crisis, investors have been chasing the yield. They have been buying up riskier assets in the hope of achieving higher returns.
Sadly, they have bought a lot of high-yield bonds. According to the Securities Industry and Financial Markets Association (SIFMA), between 2010 and 2019, almost $2.7 trillion worth of high-yield corporate bonds were issued in the United States. (Source: “US Corporate Bond Issuance,” Securities Industry and Financial Markets Association, last accessed March 3, 2020.)
Looking at current conditions, in 2018, there was a slight calm in the high-yield bond market. Issuance amounted to $169.4 billion. But in 2019, risk appetite jumped and investors gobbled up $278.3 billion of high-yield bonds. That’s a rise of over 64%.
The Blueprint For the Next Financial Crisis
Here’s the problem: it’s very likely that an economic slowdown is ahead.
Have you seen the yield curve lately? Its pretty loud and clear that things are not looking good for the U.S. economy. A lot of economic data supports this argument.
The global economy isn’t doing too well either. Indicators left, right, and center say a global recession could be inevitable. Major economic hubs are struggling to show any growth. China, Japan, Germany, France, Australia, New Zealand, Brazil, Canada, the U.K., and many others have been reporting dire economic data.
Adding more to the misery, we are in the midst of a coronavirus outbreak. The longer this goes on, it will only make the case for a recession in the U.S. economy and global economy.
What does it all mean for high-yield bonds?
Dear reader, in times of economic slowdown and when there are shocks to the economy, those who are the weakest get in trouble first.
In the case of a slowdown, we could see the companies that issue high-yield bonds run into trouble. Remember, just over the past decade, almost $2.7 trillion worth of these bonds have floated around in the U.S. alone.
Don’t you think it could lead to a bigger problem? It could trigger a financial crisis.
Imagine what happens to a pension fund that bought high-yield bonds in the hope of earning higher returns when, all of a sudden, it finds that the debt it bought is not there anymore. This could have dire consequences across the board.
Obviously, with time, we will know more. But, in the meantime, the topic of high-yield bonds is something that shouldn’t be ignored.