David Stockman on the Return of Negative Yields… And What Comes Next

When you’re losing money after inflation with the highest yields available in the bond market—junk bond yields—you know the bond market is seriously distorted by central banks. From David Stockman at internationalman.com:

Negative Yields

Among all the financial market distortions and misallocations that result from the Fed’s money-pumping policies, we are hard pressed to think of something stupider and more counterproductive than negative real yields on junk bonds.

The historic yield spread over inflation of riskiest US company securities has ranged between 500 and 1,000 basis points (5–10%) or more. And for the good reason that in combination, inflation and defaults always eat deeply into the coupons so as to remind investors why it is called “junk.”

As it happened, the junk bond yield on the eve of the dotcom crash in the spring of 2000 was 12.48%, reflecting an 875 basis point spread over the CPI of 3.73%.

By the eve of the Great Recession in November 2007, the junk yield had fallen to 9.15% but that still represented a healthy spread of 478 basis points over the CPI, which had increased to 4.37% during the prior 12 months.

But those spreads self-evidently were not enough when the economy plunged into the tank during 2008–2009.

The reason the spread went nearly parabolic during the Great Recession is that the price of junk bonds collapsed by 26% as investors and speculators dumped them in the face of soaring losses and issuer bankruptcies that topped all previous cyclical highs (dotted line).

Needless to say, the Fed was not about to let Mr. Market have its way, nor honest price discovery to win out in the bond pits.

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