European Junk Bonds Are Expensive
There is a noticeable difference between the European high yield debt market and U.S. treasuries. High yield debt no longer has a high yield in Europe and America as European junk bond yields are close to the AAA rated U.S. debt. That’s because of relentless ECB corporate bond buying which has made it the central bank with the largest balance sheet. Barclays did an analysis of European junk debt versus American junk debt which you can see in the chart below. As you can see, the Pan European high yield market ex-financials has a historically high yield compared to the U.S. high yield market ex-financials. That difference is partially because of the difference in the ratings breakdown between the two markets. The U.S. has more CCC rated bonds which are the worst rated bonds and less BB rated bonds which are the best rated junk bonds. The low rated U.S. bonds are mainly in the energy sector. That ratings difference means you’d expect U.S. bonds to have higher yields. However, adjusting for that, there is still a 12 basis point spread between the two markets. That is in the 60th percentile looking back at the past 2-3 years of data. As you’d expect, while the ECB bond buying program pushes junk bond yields lower, the liquidity of the capital markets means some of the money flows to U.S. to get the arbitrage between the two markets. That’s why the difference isn’t more substantial.
The difference between the European junk debt market and the U.S. treasury market is still historically low because the difference between the American junk bond market and treasuries is low. It’s also worth noting that the chart I used in a previous article comparing European junk to treasuries only looked at BB rated bonds, so it adjusted for the fact that Europe has 67% of its junk bonds rated BB. Central bank bond buying is suppressing yields across the board, making it tough to determine how expensive assets are relatively speaking. If you’re looking for more yield than treasuries, buying U.S. junk debt makes sense over European junk debt. I would argue you’re picking up dimes in front of an oncoming train because when default risks rise, you will be in a lot of pain. I don’t think default rates will rise in the next few months, yet I still find the risk tough to stomach. It’s a matter of risk tolerance and capital allocation.
Leave A Comment