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Oxymoron Alert: Some ‘High Yield’ Bonds Go Negative

For junk bonds that have negative yields, peculiar characteristics help explain their especially ultralow rates

In the latest sign of financial markets going into uncharted territory, more than a dozen junk bonds, which usually carry high yields, now trade in Europe with a negative yield.

It is a stark illustration of how ultraloose monetary policies have turned debt investing into a choice about how to lose the least amount of money.

European investors have gotten used to paying for the privilege of owning safe government bonds with negative yields, a kind of backward interest rate that shows the rate at which your money will shrink over time. Investors have also gotten used to highly rated, investment-grade companies trading with negative yields.

But junk bonds are typically risky borrowers with weaker balance sheets and often smaller businesses that may struggle to pay back what they borrow anyway.

“It is a perverse situation,” said Colin Purdie, chief investment officer for credit at Aviva Investors. “It is called ‘high yield,’ so to get a negative yield is pretty unusual. But it’s not completely crazy. For some investors, there is an acceptance that it’s not about absolute returns, but relative returns.”

There are about 14 companies with junk bonds worth more than €3 billion ($3.38 billion) that are trading with negative yields, according to Bank of America Merrill Lynch. They include telecom giant Altice Europe NV and tech-equipment company Nokia Corp.

The Bank of America analysts, who monitor all major corporate bonds in Europe, say they hadn’t seen any negative-yielding junk bonds until recently.

Pushing yields to record lows: The European Central Bank has hinted it will cut its already-negative policy rate in coming months or unveil a restart to its bond-buying stimulus program. Meanwhile, a shortage of high-quality government and corporate bonds has led investors to buy riskier debt to find some income.

To be sure, most junk bonds are still solidly in positive-yielding territory. The yield for BB-rated bonds, the top end of junk, in the ICE Bank of America Merrill Lynch euro high-yield index is 1.9%—down from 3.6% in January—while the average for all junk-rated debt in the index is 3%, down from 4.9%.

And the junk bonds that have negative yields sport peculiar characteristics that help explain their especially ultralow rates.

About half of the negatively-yielding junk bonds have a chance of being repaid early. For some of these, investors buying them now are paying more than their repayment value if they get called, so they would definitely lose money. For example, Mary Pollock, telecoms analyst at CreditSights, points to Altice Luxembourg’s 2022 bonds, which are currently callable, but trade at a price above the call price. They have a yield to call of minus 7.65%, but a yield to maturity of 6.04% (positive), according to FactSet data. Investors may be betting the company doesn’t redeem the bonds.

Others have definite near-term repayment dates, but are improving companies and nothing is likely to go wrong before the bonds are paid back. Investors buying such bonds will lose less than if they put their money on deposit, for example.

One euro junk bond from U.S. packaging company Ball Corp , for example, trades at a yield of minus 0.2% and matures in December 2020. That compares to a European deposit rate of minus 0.4%, or a yield on a German government bond with a similar maturity of about minus 0.7%.

The choice for investors is about the balance between needing to stay invested and how much risk to take, according to Tim Winstone, a fixed-income portfolio manager at Janus Henderson.

A bond like Ball Corp’s is “a safe place to hang out,” Mr. Winstone said. “And just because something is negative yielding, that doesn’t mean it can’t get more negative yielding.” Falling yields mean rising bond prices and gains for investors, at least on paper.

Many expect more bond yields to go negative as central banks in the U.S. and Europe cut interest rates or return to bond buying to stimulate economies. In Europe especially, investors are realizing that negative interest rates are going to last a long time because the ECB needs to overshoot its inflation target to make up for the long spell when inflation has been far below 2%. Without a period of higher inflation, it won’t meet its target on average over the medium term.

The number of junk-rated companies with negative-yielding bonds will definitely go up, according to Barnaby Martin, credit strategist at Bank of America Merrill Lynch. “It doesn’t take much for it to go from 14 companies to 30 or 50 or 100,” he said.

At the moment, about 2% of the European high-yield market has negative yields and Mr. Martin said that if there was just a 0.4 percentage-point reduction in average spreads—or the extra yield that junk bonds pay over safe government debt—then about 10% of the market would be at negative yields.

“Investment grade is nuts,” says Mr. Winstone. “About 24% of my benchmark yields less than zero.”

The next step in junk bonds could be even more surprising. “I expect to have a high-yield company issue a negative-yielding bond,” said Martin Reeves, head of high yield at Legal & General Investment Management.

“Many investors need a positive income solution and that will force them into high yield and so lead to yields compressing.”

Company executives, FAA engineers and regulators have expanded their safety analyses to cover a growing list of issues

Boeing Co. BA 1.76% ’s 737 MAX planes are unlikely to be ready to carry passengers again until 2020 because of the time it will take to fix flight-control software and complete other steps, an increasing number of government and industry officials say, even as the company strives to get its jet back into service this year.

The situation remains fluid, no firm timeline has been established and Boeing still has to satisfy U.S. regulators that it has answered all outstanding safety questions. But under the latest scenario, the global MAX fleet is now anticipated to return to the air in January 2020, a full 12 months after the plane maker proposed its initial replacement of software eventually implicated in a pair of fatal crashes—one in October and one in March—according to some Federal Aviation Administration officials and pilot-union leaders.

The process of developing and certifying revised software and pilot-training changes has been repeatedly delayed, with airlines scrambling to cope with slips month after month.

Boeing executives, FAA engineers and international aviation regulators have steadily expanded their safety analyses to cover a growing list of issues spanning everything from emergency recovery procedures to potentially suspect electronic components. Some of those assessments are further complicated because they also cover earlier 737 models.

Already, carriers have given up on flying their MAX planes until late this year. American Airlines Group Inc. said Sunday that it would keep the plane off its schedules through Nov. 2, two months beyond its previous target of an early September return. It is the fifth time American has pushed off MAX flying since it first had to call off flights when regulators grounded the plane in March.

United Airlines Holdings Inc. announced a similar move on Friday, but FAA officials and others tracking the issue said there is no assurance the November date will hold.

Airlines didn’t expect to be in this position at this point in the year, with no end to the grounding in sight. When American first decided to scrub MAX flights for much of the summer, executives said they were doing it to save customers from last-minute cancellations but were still “highly confident” the plane would return sooner.

Instead, they have had to cope without their MAX jets through what has proven an exceptionally busy summer. The Transportation Security Administration has notched eight of the 10 busiest days in its history since May.

Senior Boeing executives and some FAA leaders have told government and industry officials they still expect the agency to be ready to lift the grounding in the fall, which presumably would enable the jets to resume carrying passengers before the end of the year.

But based on a history of previous delays and unexpected technical challenges, many of these officials said, at this point sentiment seems to be building that a conservative January timeline is more realistic.

The FAA has said it is following a thorough process that has no timetable, with agency leaders vowing to resolve all safety issues before allowing the planes back in the air.

Boeing has said it intends to “provide the FAA and the global regulators whatever information they need,” noting that the company won’t offer the 737 MAX “for certification by the FAA until we have satisfied all requirements” for such approval and safe return to service.

The specific software fix for MCAS—an automated system that misfired, overpowered pilot commands and strongly pushed down the noses of both of the MAX airliners that crashed—has been essentially completed and has been awaiting formal FAA approval for months.

But in the intervening period, Boeing and safety regulators have been delving into various related issues that cropped up from earlier engineering studies, ground-simulator sessions and flight tests.

During early stages of work on the fix, Boeing and FAA officials disagreed behind the scenes about the extent of changes needed to reduce hazards posed by the MCAS system, according to people familiar with the details. Then in March, just as Boeing was slated to submit a long-awaited proposal with the goal of jump-starting the process, new questions arose about related software systems and emergency checklists, requiring weeks of additional intense evaluation.

The topics included concerns about whether the average pilot has enough physical strength to manually crank a flight-control wheel in extreme emergencies.

In late June, Boeing and the FAA disclosed still another flight-control problem on the MAX, involving failure of a microprocessor that meant test pilots couldn’t counteract a potential misfire of MCAS as quickly as required.

Since the 737 MAX and its earlier version, called the 737 NG, share the same flight-control computer, fixes related to the microprocessor also apply to NG models, thousands of which remain in service around the world. Boeing also faces the task of convincing the FAA that a software fix, instead of physically replacing the suspect electronic component on all MAX planes, will suffice.

Even assuming new MAX issues don’t crop up, Boeing will need FAA approval for its entire suite of fixes, not just those directly related to MCAS, along with a new round of flight tests, a green light for enhanced training procedures and approval of updated simulator software.

In addition, airlines have said it could take them up to 45 days to complete necessary maintenance procedures and other mandatory checks by mechanics to bring MAX aircraft out of storage.

From a purely technical standpoint, some senior FAA officials believe they could be in a position to approve Boeing’s proposed fix at some point in October, though working with international regulators on a coordinated return to service could cause a delay, according to one person briefed on the matter. Another wild card, this person added, relates to the potential impact of new FAA leadership if the U.S. Senate confirms Stephen Dickson in the fall as the next agency administrator.

Each month the plane’s return is delayed means a new puzzle for airlines: how to build a new schedule that covers as much flying as possible with fewer jets. Some customers who had already planned flights have to be rebooked—sometimes at a less convenient time or with an added stop. Pilots and flight attendants also have to be reshuffled.

Now, carriers are nervously eyeing the holiday season, when they will face a crush of travelers whose Thanksgiving and Christmas travel plans leave little wiggle room. United was supposed to have 30 MAXes in the coming months, up from 14. As a result it is cutting 2,900 flights in October—more than twice the number it has had to cull in July. American Airlines had 24 MAXes in its fleet at the time of the grounding—less than 3% of its total. But it was supposed to have 40 by the end of the year.

At Southwest Airlines Co. , Alan Kasher, vice president of flight operations, said in a message to employees Friday that the airline is “overstaffed,” with more pilots than it needs to operate a shrunken schedule stemming from the grounding of its 34 MAX jets. Some Southwest pilots have complained of lost earnings from fewer flying opportunities.

With the timing of the MAX’s return still murky, the airline is postponing training for some newly hired pilots who were set to start this fall and pushing back training for some current Southwest co-pilots on track to upgrade to captain.

Shares fall nearly 15% as deal failure strikes major blow at Australian insurer

AMP Limited warned on Monday that the A$3.3bn ($2.3bn) sale of its life insurance business to London-based Resolution Life is highly unlikely to proceed due to strict capital requirements set by New Zealand’s central bank. 

A failure to complete the transaction would mark a major blow to the financial services company, which had negotiated the sale of its Australian and New Zealand life insurance businesses as the centrepiece of a major restructuring plan. 

AMP shares fell as much as 14.7 per cent in afternoon trading in Sydney on Monday to a fresh record low, after the company also announced that it was unlikely to pay an interim dividend this year.

“I think this is a major headwind for AMP’s turnround,” said Chanaka Gunasekera, an analyst at Morningstar.

“The sale of the life business would make AMP a simpler, less capital-intensive business, which I suspect is part of the reason the new management was looking to sell this business,” he added. T”his part of the strategy is now obviously unlikely to occur.”

AMP said Resolution Life had informed it that the Reserve Bank of New Zealand would not sanction a change of control application for the New Zealand life insurance business unless it agreed to have separate, ringfenced assets, held in New Zealand.

As a result, Resolution Life does not expect RBNZ to approve the transaction under its current terms, said AMP. 

AMP added that meeting the RBNZ requirements would have an adverse impact on the commercial return of the sale for both AMP and Resolution Life. 

“The failure to meet [RBNZ capital requirements] is exceptionally disappointing as the sale of AMP Life is a foundational element of AMP’s strategy,” the company said.

“AMP is now working with Resolution Life to determine whether there is a solution that addresses policyholder interests, regulatory requirements and provides certainty of execution,” it added. 

AMP, Australia’s largest wealth manager, has been hit by damaging revelations exposed by a public inquiry into misconduct in the financial sector, including that it charged fees to dead customers and lied to regulators. This led to the resignation of its chairman and chief executive last year and forced the new management to implement a major restructuring plan. 

A collapse of AMP’s proposed sale of its life insurance business to Resolution Life would represent the first direct consequences of the RBNZ’s proposed new capital requirements policy.

The central bank wants to force banks and other financial services firms to hold more regulatory capital to enable them to withstand a once in every 200 years financial crisis.

Australia’s main banks have warned the higher capital requirements would dent profits and could lead them to substantially raise loan costs and even dispose of New Zealand subsidiaries.

China’s economy recorded its slowest rate of economic growth in almost three decades in the second quarter, which analysts believe will likely pave the way for additional easing measures before the end of the year.

The world’s second-biggest economy expanded by 6.2 per cent in the three months to June, official statistics showed on Monday, in line with expectations but below the 6.4 per cent seen in the first quarter. 

However, economists pointed to a strong set of data for June, including robust figures for manufacturing and retail sales. 

Capital Economics analysts Julian Evans-Pritchard and Martin Rasmussen said the Chinese economy was likely to weaken further in the second half of the year.

Activity held up better than anticipated, but we expect this strength to be temporary.

Looking ahead, we doubt that the better-than-expected data for June will mark the start of a turnaround. Even with fiscal policy turning more supportive again, we think that construction activity will come under pressure in the coming quarters as the recent boom in property development unwinds.

Larry Hu, an economist at Macquarie, said that the improvements seen in June’s data were unsustainable and paved the way for more stimulus before the end of the year.

We expect stimulus to escalate around 4Q19, when policy makers would put economic growth as the top priority again. At that time, they would lower interest rates to support the property sector, loosen regulation to boost infra spending, and roll out measures to stimulate consumer durable goods such as auto and home appliance.

ANZ analyst Raymond Yeung said the Chinese economy would only need to go grow by 5.8 per cent in the second half to reach the government’s 2019 growth target of 6 per cent.

In our view, the Chinese government will not allow the quarterly growth to fall below 6.0%. Last year, President Xi Jinping stated the 70th anniversary of People’s Republic of China would be celebrated with outstanding economic performance. In 2018, H2 saw 52% of China’s GDP produced. If H2 GDP can expand by 6.0%, full year GDP will still be 6.1% in 2019.

However, Mr Yeung expressed concerns over the potential effectiveness of additional easing measures.

We remain concerned about whether the credit expansion can boost real economic activities. We believe the People’s Bank of China will continue to adopt a targeted policy as opposed to quantitative easing to support growth.

Hao Zhou, an analyst at Commerzbank, said that more important than the stable headline growth figure were signs that the trade war with the US was taking its toll on the world’s second-biggest economy.

We have received a mixed picture for now, unfortunately. Several data points continue to highlight the damage of the US-China trade war on the Chinese economy. For instance, both the official and private PMIs were sluggish in June. In addition, China's imports, particularly in the manufactured goods, have experienced a slump since late 2018. 

Chinese stocks rebounded and the Australian dollar hit its highest in more than a week after signs that China’s economy is stabilizing.

Japanese markets were shut for a holiday, subduing trading as the week kicked off. Equity gauges in Shanghai and Hong Kong recouped early losses after gains in Chinese industrial production and retail sales for June beat all estimates. Australian and Korean shares also clawed back some of their loss, while futures on the S&P 500 Index were little changed. With cash trading for Treasuries closed, futures on U.S. 10-year notes dipped. West Texas Intermediate crude oil traded around $60 a barrel.

Nikkei +0.20% Hang Seng +0.00% CSI +0.16% Shanghai +0.20% Shenzen +0.70 %

Eur$ 1.1274 CNH 6.8752 CNY 6.8748 JPY 108 GBP 1.2574 CH 0.9846 RUB 63.1252 TRY 5.7242 WTI$ 59.95 -0.43%

S&P +0.09% EuroStoxx +0.20% FTSE +0.07% Dax +0.28% SMI +0.16%

Macro :

- Gina Miller to Sue Government If Johnson Suspends Parliament

- ADIA to Hire as Fund Boosts Active Investments to More Than 50%

- Dozens Arrested as Mass Hong Kong Rally Keeps Heat on Carrie Lam

- Smaller London Home-Price Drop Shows Bottom Near, Rightmove Says

Keep an eye on :

- ABI BB : AB InBev’s IPO Decision Means Slower Expansion, Liberum Says

- ABI BB : AB InBev IPO Cancellation Reduces M&A Optionality: Jefferies

- ADEB NO : Adevinta Second Quarter Ebitda 1.4% Below Estimates

- AIR FP : Boeing 737 Max Grounding Could Stretch Into 2020: WSJ

- AIR FP : Airbus Pulls 50th Anniversary Book Over Bribery-Probe Chapter

- AIR FP : Air France Plans Jet Orders at End of July, La Tribune Says

- ALSN SW : Also Holding CEO Eyes Targeted Acquisitions in Europe, FuW Says

- ANTO LN : Pakistan Ordered to Pay Barrick, Antofagasta $5.8b Compensation

- ATL iM : Alitalia Rescue Weeks Away as Delta, Atlantia Line Up for Bid

- AXFO SS : Axfood Reports Second Quarter Earnings That Beat Estimates

- BBY LN : Balfour Beatty Starts Probe Into Corruption Allegations: FT

- BAYN GY : Bayer Loses Bid for A New Trial for Second Roundup Verdict

- BNP FP : BNP Paribas Ends U.S. Prison-Operators Financing: Reuters

- CLASB SS : Clas Ohlson June Sales SEK676 Mln, +5.5% M/M

- DAI GY : Some Daimler Investors Resist Zetsche Move to Sup. Board: HB

- DBK GY : Deutsche Bank to Boost Asian Corporate Bank, Wealth Mgmt: SCMP

- RACE IM : Porsche, Ferarri to Recall Cars in China to Replace Faulty Parts

- GALP PL : Galp 2Q Average Working Interest Production 111.7 Kboepd

- GLPG NA : Gilead to Pay $5.1 Billion, Raise Stake in Biotech Galapagos

- GLPG NA : Gilead’s Higher Stake De-Risks Galapagos Investment Story: Citi

- GSK LN : Glaxo Is Said to Be in Talks to Appoint Symonds as Next Chairman

- HTZ US : Hertz Holder Icahn Exercised Rights, Reports 28.84% Stake

- INWI SS : Inwido Second Quarter EPS SEK2.05

- JE/ LN : JE/ LN (Liberum says Just Eat could be a target for Amazon if the U.S. company’s attempt to invest in Deliveroo is blocked)

- LHN SW : LafargeHolcim to Buy Romanian Concrete Maker Somaco; No Terms

- PAH3 GY : Porsche, Ferarri to Recall Cars in China to Replace Faulty Parts

- RAYB SS : RaySearch, Vision RT Announce Strategic Partnership

- REC NO : REC Silicon Reduces Workforce by Further 100 in Moses Lake

- TEL NO : Telenor Grameenphone 2Q Revenue NOK3.68B; Negative Impact

- TLW LN : +ve Barron's Article

- VOW3 GY : Harsh Reality Forces Automaker Rivals Like VW, Ford to Make Nice

* Cover story: Barron’s Roundtable participants offer big-picture views and their latest investment picks: Todd Ahlsten of Parnassus Core Equity fund (TRMB, NVDA); Rupal Bhansali of Ariel Investments (CHL, Michelin, GILD, Roche Holding, Telefonica Deutschland Holding); Scott Black of Delphi Management (USB, ABBV, DIS, LMT, HTCG, 6-month Treasury, 1-Year Treasury); Henry Ellenbogen, formerly of T. Rowe Price New Horizons fund (IT, WCN, MTN, SSNC); Mario Gabelli of Gamco Investors (BATRA, FOX, HRI, MGM, NAV, GFF, ENR); Abby Joseph Cohen of Goldman Sachs (EDU, NOC, TPR, ICLN, Recruit Holdings); William Priest of Epoch Investment Partners (CNC); Oscar Schafer of Rivulet Capital (COMM, Whitbread); and Meryl Whitmer of Eagle Capital Partners (MS, Lafarge-Holcim, FOX).

* Features: 1) The space economy, boosted by the exploits of dot-com billionaires, is taking shape. Investment opportunities are coming—Virgin Galactic plan to merge with shell company IPOA to allow it to sell shares to raise money is a case in point; 2) EXPE: Travel company faces a changing market now that Google has aggressively pushed into the sector, but while shares have lagged, they still present an opportunity for long-term investors.

* Tech Trader: A look at the big ideas coming out of storied Silicon Valley venture capital firm Kleiner Perkins, which is now focused on four areas: enterprise technology, consumer technology, financial technology, and “hard technology,” which includes companies focused on the “fundamental new building blocks that are required in different industries to take them to the next level.”

* Trader: “With the Fed clearly pessimistic about coming U.S. economic conditions, investors’ greater focus this earnings season may be on companies’ own assessment of the future”; Positive on MCRN: After a restructuring, the company is focusing on faster-growing emerging markets, closing unprofitable plants, and streamlining its structure and technologies, and its acquisition by Hillebrand should boost profit margins and clear a path to de-levering; Positive on EVR, JEf, PJC, PJT, LAZ: Smaller firms should benefit more than many large global banks from DB’s decision to exit equity sales and trading.