Demand for junk bonds is insatiable, until it’s not. The same was true of condos in Florida in 2005, and commercial real estate in 2007. In a repeat performance of 2007, I noted Investors Chase Risk in Junk Bonds at Fastest Pace Ever

One of the signs of the extreme demand for junk can be found in swap spreads. Please consider Ten-Year Swap Spread Turns Negative on Renewed Demand for Risk.

The 10-year U.S. swap spread turned negative for the first time on record amid rising demand for higher-yielding assets such as corporate and emerging market securities.

The gap between the rate to exchange floating- for fixed- interest payments and comparable maturity Treasury yields for 10 years, known as the swap spread, narrowed to as low as negative 0.44 basis point, the lowest since at least 1988, when Bloomberg began collecting the data. The spread narrowed 3.38 basis points to negative 0.38 basis point at 12:40 p.m. in New York.

A negative swap spread means the Treasury yield is higher than the swap rate, which typically is greater given the floating payments are based on interest rates that contain credit risk, such as the London interbank offered rate, or Libor. The 30-year swap spread turned negative for the first time in August 2008, after the collapse of Lehman Brothers Holdings Inc. triggered a surge of hedging in swaps. The difference narrowed to negative 18.56 basis points today.

“It’s hedge-related activity related to new corporate issuance,” said Christian Cooper, an interest-rate strategist at Royal Bank of Canada in New York, one of 18 primary dealers that trade with the Federal Reserve. “As more and more institutions receive, then swap rates will go lower.”

The extra yield investors demand to own corporate bonds rather than government debt was unchanged yesterday at 154 basis points, or 1.54 percentage points, the narrowest since November 2007, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. High-yield debt returned a record 57.5 percent in 2009, and another 4.3 percent this year, according to the Bank of America index data.

Interest Rate Hedging

One can dismiss this as hedging, or one can note references to 2007 that keep popping up over and over:

“The extra yield investors demand to own corporate bonds rather than government debt was unchanged yesterday at 154 basis points, or 1.54 percentage points, the narrowest since November 2007

Inquiring minds are reading Junk Bonds Selling at Briskest Pace Since 2007.

Companies are selling high-yield, high-risk bonds at the fastest pace since credit markets seized up in 2007 amid signs the economic recovery is gaining momentum.

Renault SA, the second-largest French automaker, Pittsburgh-based U.S. Steel Corp. and other speculative-grade borrowers issued $24.2 billion of high-yield notes in March through last week, putting this month on course to be the busiest since June 2007, according to data compiled by Bloomberg.

As long as the demand for garbage continues, stocks will likely fetch a bid.

However, risk taking is at extreme levels just as it was in 2007. I want no part of it.

Mike “Mish” Shedlock
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