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Third Avenue Fallout to Decimate US Bond Market

© Flickr / ctj71081 / Marriner S. Eccles Federal Reserve Board BuildingThe US Federal Reserve "is going to launch QE4 for the same reason they launched QE3, 2 and 1. They're going to try to stimulate the economy. Now that they stopped QE, the air is coming out of this bubble," says financial analyst Peter Schiff.
The US Federal Reserve is going to launch QE4 for the same reason they launched QE3, 2 and 1. They're going to try to stimulate the economy. Now that they stopped QE, the air is coming out of this bubble, says financial analyst Peter Schiff. - Sputnik International
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The unraveling drama in the US junk bond market might greatly contribute to the economic slowdown anticipated as a side-effect of the US Federal Reserve’s rates increase, also undermining the credibility of bonds issuance as a tool to attract capital.

Kristian Rouz — Last week’s Wall Street anxiety over the freeze in payoffs and the subsequent closure of the Third Avenue credit fund is rapidly spreading to the entire market of the US commercial bonds, threatening to impair the investment in US energy projects, among other ventures, and to worsen the overall economic growth outlook.

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US ‘Junk Bond' Market About to Crash on Fed Hike
As if the concerns over the US Federal Reserve’s coming rise in borrowing costs were not grave enough, investors are now expecting a massive decline in high yield bonds, with some 10% to 15% of the market evaporating due to capital withdrawals from the industry.
US bond investors are concerned with the opened prospect of them not getting their money back, while the US junk bond drama is unraveling on Wall Street.

Risky corporate bonds are on a selloff, while the struggling US companies, in particular those hit by the slump in energy prices and the ongoing appreciation of the US dollar, are losing their last source of investment capital.

The $788.5 bln-worth Third Avenue collapse might now trigger a domino effect in the US bond market that flourished since the end of financial crisis in 2009.

Another fund, Stone Lion Capital Partners, froze payoffs on their $400 bln debt holdings due to too many investors demanding their money at once. Yet another junk bond fund, the London-based Lucidus Capital Partners, founded in 2009, announced on Monday it would liquidate its assets next month.

“The risk is that this is going to cascade into something bigger,” Scott Minerd of the Santa Monica, CA-based Guggenheim Partners said. “If we’re going to see contagion, the most vulnerable funds are going to be the ones that are down significantly.”

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So far, the US junk bond market has declined an average 2% at the close on Friday, according to the SPDR Barclays High Yield Bond ETF, the benchmark of the industry, with the likes of the $211 mln-worth AdvisorShares Peritus dropping 4.3% in the stock trading that day, and the ProShares Ultra, another junk bond fund, declining 5.8%.

Mutual funds allow their investors to deposit or withdraw money on a daily basis, while exchange-traded funds (ETFs) provide an opportunity to increase or decrease investors’ portfolio during each day, resulting in a one-time massive investors’ rush to withdraw amidst the anxiety – a challenge many funds have proven unable to address.

The Third Avenue Focused credit Fund crashed on December 9 after its biggest investment project, the now-bankrupt Energy Future Holdings Corp., was proven to be too much of a toxic asset to handle.

“The real question is going to be how many hedge funds go bankrupt,” Jeffrey Gundlach, the Los Angeles-based money manager overseeing $80 bln worth of assets, said. “There’s never one cockroach. There’s never just one portfolio that’s mismarked.”

Tougher regulations imposed by the US authorities on capital investment in the aftermath of the 2008 crisis have rendered most US assets less liquid and increasingly volatile, which, coupled with the looming Fed hike in rates and a decline in returns from the once-booming US shale industry, all contributed to the fallout in high yield bonds.

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Meanwhile, risk premiums on top-100 US high yield bond finds skyrocketed by 10% on Friday, signaling an unprecedentedly high volatility and a potential upcoming crash of the industry. However, investors are not buying into these assets any longer, fearing they would join the ranks of those who already cannot pull their capital invested in junk bonds.

The structural problem in the US credit market might eventually result in a massive blow to the credibility of the entire institution of corporate bond issuance. Many companies in the real economy find themselves stripped of cash and cut off of investment resources, meaning the junk bond downturn may add to the slowdown in GDP expansion, already expected as a consequence of the Fed hike in borrowing costs.

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