Bank bonds might feel the biggest loss if higher interest rates trigger a sell-off of corporate debt, said Hans Mikkelsen, head of US investment-grade credit strategy at Bank of America Merrill Lynch. "Bank bonds are going to be the vehicles for redemptions in the corporate-bond market," he said. "So if you own a lot of bank bonds, you risk underperforming in the next one to two years."
The strengthening economy and prospect of rising interest rates could prod investors to turn away from high-yield bonds, analysts say. "Not only do too many macro headwinds exist to create a compelling story for high yield, but fundamentals are the weakest they have been since the recession -- likely creating an environment where looking for a reason to sell becomes easy," according to analysts at Bank of America Merrill Lynch.
Uncertainty about interest rates is undercutting demand by bond buyers and forcing borrowers to postpone offerings. A half-dozen deals aimed at raising more than $300 million have been pulled from the municipal bond market. Four days have passed without a single high-yield or investment-grade offering coming to the corporate-bond market.
Investors in high-yield bonds are dismissing fears that an economic double-dip would prompt an increase in corporate defaults, as they bet they will be fully repaid for the first time in years. The average price for high-yield debt has surpassed 100 cents on the dollar for the first time in more than three years, according to Bank of America Merrill Lynch. Prices fell as low as 55 cents in late 2008.
Buyers of European high-yield bonds are signaling their confidence that Greece will make it through its sovereign-debt problem. This year, Europe's high-yield bonds have brought a 2.26% return, according to Bank of America Merrill Lynch. Meanwhile, U.S. high-yield corporate debt has given investors a 0.36% loss. "Greece is seen as more of a concern for the banks and investment-grade than for high yield," said Martin Fridson, CEO of Fridson Investment Advisors.