Real euro junk yields are not negative so much as pathetic
On Tuesday the FT reported the following, under the headline “Real yields on European junk bonds go negative for first time”:
The yield on ICE BofA index of European high-yield bonds was pushed down to 2.34 per cent this week, marking the first time buyers of so-called high yield European currency bonds have accepted payments below consumer price inflation in the eurozone, which hit a decade high of 3 per cent in August.
All true, but if I buy a junk-rated bond with (say) five years to maturity, I don’t care about the inflation rate now; I care about the rate of inflation over the next five years. And expectations for inflation in the eurozone over the next five years are lower than 2.34 per cent. As of Thursday, according to the five-year five-year euro inflation swap, inflation is expected to run at 1.75 per cent over that period. The junk yield has surged back to 2.4 per cent, leaving a princely real junk yield (the nominal yield minus expected inflation) of 65 basis points.
Tomas Hirst of CreditSights made this point on Twitter, pointing out that euro junk traded at slightly lower real yields back in 2017:
My question for him was, yes, real yields are positive, but how is anyone going to make money buying this stuff with 65bp of real yield? This seems bonkers. He said:
You are not jumping up and down saying there is great value here. We all understand that if defaults pick up, that is a problem, because you are not being compensated for that . . . you are not even being compensated for supply risk. We think there is a lot of leveraged buyout financing coming — perhaps €25bn to €30bn worth — and a lot of that is going to hit the B tier [the second-highest rung of high yield] . . . It doesn’t take a lot to make investors say, do we want to own this stuff, or do we want to own the stuff that is coming to market, which has to pay [a higher yield]?
We live in a world priced for very, very, very low returns.