By Michael Aneiro
Bank of America Merrill Lynch today undertakes the tricky task of using history as a guide to figure out what might happen to junk bonds if interest rates were to rise rapidly. Tricky because there’s never really been a truly similar period in terms of rates being as low as they are now.
But looking at previous periods of rising rates, BofA says on average high-yield spreads over Treasuries tightened by 43 basis points into a 153 bps average increase in 5-year yields, and BofA found that such periods produced significant outflows from high-yield bond funds. From BofA:
Now, we would like to emphasize that these episodes measure the exact timing of impact of some of the worst rate jumps in the modern history of financial markets. In other words, it may be exaggerating the extent of an impact given the severity of those very episodes…. [A]t its worst, the rapid rate increase has capacity to derail HY market’s ability to meaningfully offset it with spread tightening. Precisely at the time when it is needed the most.
Finally… mutual funds were seeing net negative flows in every single period of rapidly rising rates, averaging 4.8% across all of them. Given today’s asset size in this market segment, an outflow of this magnitude would translate into a $17bn outflow from weekly reporting global HY funds. This is as good a parallel as it gets to put this week’s $1.2bn outflow from HY into historical perspective.