Low oil prices are killing the junk bond market

An asset class beatdown in motion tends to stay in motion.
An asset class beatdown in motion tends to stay in motion.
Image: AP Photo/Hasan Jamali
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Oil prices have taken a break from their most recent nosedive, with international benchmark Brent crude rising above $38.50 a barrel and US benchmark West Texas Intermediate bubbling above $37 today (Dec. 15).

Unfortunately, credit markets are still dealing with the havoc unleashed by low prices.

In the headier days of the oil boom, energy companies rushed to borrow while the getting was good. In the process, they came to take up a larger portion of the market for “high-yield” bonds, also known as junk.

As crude prices have fallen, it’s become harder for those energy companies to refinance as the search for yield gets less intense as the Federal Reserve prepares to raise interest rates. That means high-yield bonds are going to lose money for investors stuck holding the bag. So far, the Barclays high-yield corporate bond index is down almost 6% this year, and the energy-focused equivalent has lost just over 22%.

And that bag is getting heavier by the day. The most prominent casualty of the junk bond collapse has been hedge fund Third Avenue Management’s Focused Credit Fund, the closure of which forced the firm to bar investor withdrawals and has drawn attention from the Securities and Exchange Commission and the Massachusetts Securities Division, the state’s financial regulator.

But Third Avenue isn’t the only fund feeling the heat: The Wall Street Journal reported (paywall) that other asset managers with big junk bond funds have been besieged by investors requesting their money back or selling shares.

Bank of America Merrill Lynch put out a client note today suggesting the carnage may have only just begun.

“We sit here today and question whether or not the weakness we expect for next year has been brought forward to this year. After careful consideration, we don’t believe so,” the bank’s analysts wrote. “The fact of the matter is the last week has not changed one key view in our outlook: that we are at the beginning of the end of the credit cycle.”