Federal Reserve Chairman Ben Bernanke on Tuesday said that the Fed was worried about portfolio managers “reaching for yield” in a zero-interest-rate environment, but not too worried. The benefits outweigh the risks, he said. But with the continued growth in the high-yield market, the Fed might change its mind eventually.
According to Fitch Ratings, the European High-Yield market is continuing its 2012 surge with a strong start to 2013. That’s because there are few yield opportunities for portfolio managers and “a lack of financing alternatives in either the volume or the duration required by EHY issuers.” And it could get even better for those searching for yield as the list of “fallen angels” in Europe grows. These are the investment-grade companies that are migrating down the ratings scale.
“Fitch anticipates weak European growth to negatively impact rating migrations, which could ultimately bolster the asset class as more investment-grade rated corporates fall into the speculative-grade category – albeit at the cost of a higher volatility of returns,” Fitch said in its European High-Yield Chart Book for February 2013.
Earlier Tuesday, Chairman Bernanke, appearing before the US Senate’s Committee on Banking, Housing, and Urban Affairs, said a potential cost of current policy “is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may ‘reach for yield’ by taking on more credit risk, duration risk, or leverage.” But so far, “we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation.”
The problem, according to Fitch, is that as yields and spreads continue to compress, “investors may tempt riskier lower ‘B’ and even ‘CCC’ issuers from the leveraged loan market to issue high-yield bonds.” Although Fitch said new-issue volumes from lower-rated issuers “have historically remained small relative to the broader ‘BB’ rated issuer mass,” it does point to a heightening of the risks the Fed is now only a little worried about. Fortunately, the default rate has fallen slightly in Europe (which is opposite the trend in the US, according to Fitch), so the growth and the underlying confidence – driven by the European Central Bank’s Outright Monetary Transactions (OMT) – will likely remain.