Euro Junk Bonds and “Reverse Yankees” Go Nuts

The most obviously lopsided deals.

The ECB’s efforts to buy corporate bonds as part of its stupendous asset buying binge has not only pushed a number of government bond yields below zero, where investors are guaranteed a loss if they hold the bond to maturity, but it has also done a number – perhaps even a bigger one – on the euro junk-bond market.

It has totally gone nuts. Or rather the humans and algorithms that make the buying decisions have gone nuts. The average junk bond yield has dropped to an all-time record low of 2.42%.

Let that sink in for a moment. This average is based on a basket of below investment-grade corporate bonds denominated in euros. Often enough, the issuers are junk-rated American companies with European subsidiaries – in which case these bonds are called “reverse Yankees.”

These bonds include the riskiest bonds out there. Plenty of them will default, and losses will be painful, and investors – these humans and algos – know this too. This is not a secret. That’s why these bonds are rated below investment grade. But these buyers don’t mind. They’re institutional investors managing other people’s money, and they don’t need to mind.

It’s perfectly good to invest in risky instruments as long as you’re being paid to take those risks or have a chance to make serious money. If you buy gold and silver bullion, you know you could make or lose a lot of money. But at a yield of 2.42%, these junk bonds will never make any money if you hold them to maturity, except for covering mild inflation. The risk of losses – including from default – are large. And investors are not getting paid to take those risks. It’s one of the most obviously lopsided deals out there.

The average yield of these junk bonds never dropped below 5% until October 2013. In the summer of 2012, during the dog days of the debt crisis when Draghi pronounced the magic words that he’d do “whatever it takes,” these bonds yielded about 9%, which might have been about right.

Since then, yields have plunged (data by BofA Merrill Lynch Euro High Yield Index Effective Yield via St. Louis Fed). The “on the Way to Zero” in the chart’s title is only partially tongue-in-cheek:

The chart below gives a little more perspective on this miracle of central-bank market manipulation, going back to 2006. It shows the spike in yield to 25% during the US-engineered Financial Crisis and the comparatively mild uptick in yield during the Eurozone-engineered debt crisis:

How does this fit into the overall scheme of things? For example, compared to the US Treasury yield? US Treasury securities are considered the most liquid and the most conservative investments. They’re considered as close to a risk-free financial instrument as you’re going to get on this earth. Turns out, from November 2016 until now, the 10-year US Treasury yield has ranged from 2.14% to 2.62%, comfortably straddling the current average euro junk bond yield of 2.42%

This chart shows the BofA Merrill Lynch Euro High Yield Index (red line) and the 10-year Treasury yield (black line). Note how they used to be worlds apart, and how the spread between them blows out when investors suddenly see risks again, with junk bond prices plunging and yield surging, while Treasuries barely quiver:

If you want to earn a yield of about 2.4%, which instrument would you rather have in your portfolio, given that both produce about the same yield, and given that one has a significant chance of defaulting and getting you stuck with a big loss, while the other is considered the safest most boring financial investment out there?

The answer would normally be totally obvious, but not in the Draghi’s nutty bailiwick. That this sort of relentless and blind chase for yield – however fun it may be today – will lead to hair-raising losses later is a given. And we already know who will take those losses: The clients of these institutional investors, the beneficiaries of pension funds and life insurance retirement programs, the hapless owners of bond funds, and the like.

In terms of the broader economy: When no one can price risk anymore, when there’s in fact no apparent difference anymore between euro junk bonds and US Treasuries, then all kinds of bad economic decisions are going to be made and capital is going to get misallocated, and it’s going to be Draghi’s royal mess.

In the US, “covenant-lite” loans – risky instruments issued by junk-rated borrowers, with few protections for creditors – set an all-time record at the end of the second quarter. Read…  Risk has been Abolished, According to Institutional Investors

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  52 comments for “Euro Junk Bonds and “Reverse Yankees” Go Nuts

  1. Maximus Minimus says:

    Michael Milken should sue for wrongful conviction, or Mario should go to jail. I know which I would prefer.

    • Haus-Targaryen says:

      I’m not sure what I should take from this …

      Investors trust the euro junk-bond market more than 10 year UST (given the Fed can print fiat, this seems rather inflationary outlook for the USD) or investors think there is more upside in the euro than the USD.

      It would be interesting to see high-yield yields in each corresponding EMU nation, to see if redenomination risk is also working behind the scenes here.

      We live in interesting times.

      • Wander Lust says:

        Saw similar distortions in credit spreads in 2006 when out marketing a fund to position ahead of the distressed debt cycle.
        The comment response was of course “what distressed?”
        ….”on its way”, we’d say.
        You would be surprised how many “institutional” investors don’t understand credit.
        You can tell them that they are not getting paid for the risk they are taking at a zero spread to Treasuries and their eyes glaze over.

  2. Jon says:

    So what is best i instrument to short this?

  3. Reed Kane says:

    Just buy Pimco RCS bond fund and enjoy a pretty consistent 8%+ yield.

    • cdr says:

      Thanks much for the closed end funds tip. I just looked RCS up and saw the others. I didn’t know about them. Look good but waiting for a fall in price first. Also need to research them more but, if they check out, I’m expecting a more comfortable retirement with them contributing.

  4. HD says:

    Having followed this soap since 2008, I cannot even work myself up over all this anymore. Now I am just waiting until central banks all over the world have to put a stop to their QE shenanigans. The ensuing come-to-Jesus moment will be one for the history books IMO.

    • Gershon says:

      Agreed. The fraud has become so massive and systemic, will all the central banks collaborating, that only an exogenous event like a major conflict breaking out will create shocks to the system that expose how insane stock and asset valuations have become. Future historians will marvel at how passive and complacent the 99% were as the Fed and central bankers robbed them blind and destroyed their children’s financial futures.

    • Petunia says:

      A somewhat related issue is all the cash kept overseas by the American multi nationals. They and our govt think eventually it will come back, but why would the EU allow it. In any case, I think anybody stupid enough to put their money in an Irish bank, doesn’t deserve any sympathy.

      • Wolf Richter says:

        Petunia, that money isn’t actually overseas. It is just registered at a mailbox company overseas. And then it’s invested in US Treasuries, US corporate bonds, and a variety of other investments in the US and around the world. What this money cannot be used for is buying back shares and paying dividends, among other things.

        See Apple. And this “overseas” money is managed by its people in the US. Apple has practically no cash on deposit at Irish banks.

        Last time there was a tax holiday on the repatriation of this overseas money, companies bought back their own shares with it, increased dividend payments with it, and jacked up executive compensation. No measurable number of jobs were created in the US.

        • Petunia says:

          I went out of my way not to name any company in particular because Apple is not the only one with big reserves overseas. With negative interest rates the EU banks are making a bundle on these accounts and I can’t see that they would let go that easily, no matter what the US tax policy becomes. Apples’ $50B in treasuries is only about 20% of their holdings and it has been reported they are increasing reserves overseas in anticipation of a new US tax policy. If that money can’t come back, it will get really interesting.

        • d says:

          “What this money cannot be used for is buying back shares and paying dividends, among other things.”

          Unless they Borrow it from themselves (not very hard to arrange). Then the interest due is US tax deductible.

      • d says:

        Girl you should know buy now, most of that money is in US Treasury’s or US $ Stocks/Bond’s.

        Or has been “Loaned” Back to the company’s that own it, with a big fat interest deduction, before US tax.

        • Petunia says:

          What I know is that Ireland is doing very well being a tax haven for these companies. Their economy is benefiting from this arrangement and I can’t see them or their friends at the ECB not intervening if a draw down occurs.

          Apple is ahead of the curve bringing some jobs back thru their Foxcon deal, but others are just hoping for the best. The borrow here and pay there model is a good one until it’s not.

        • d says:

          “What I know is that Ireland is doing very well being a tax haven for these companies. Their economy is benefiting from this arrangement and I can’t see them or their friends at the ECB not intervening if a draw down occurs. “????????

          Friends at the ECB??????? Ireland dosent have friends at the ECB or the EU commission any more. The EU wants ireland to Collect from apple 13+ billion in what they claim should be Back taxes. And off course hand over to the EU Administrators, their cut of that.

          This matter is ongoing still.

          As foir apple being “Ahead” of the job return cure .

          NOT So. apple and Nike, along with Hard drive, and other computer component suppliers, were the leaders in the “Export that Job” Period in the west.
          Logically they are the entities to watch to show us when that model is no longer viable.

          Both are returning assembly to the US, BUT NOT with any VOLUME OF JOB’S, as their new US assembly plants/lines are HIGHLY robotically automated.

          There was and interesting Bloomberg article a while ago based on the Asian and 3Rd world development model being Broken. By Automation.

          It showed the cycle from High labour Textile and other high labour unskilled manufacturing through to developed industrialisation. And nations that had in the past ridden it

          It mentioned that as costs rose in job and industry thief china, work had been leaving, this had been stopped in some sectors by automation.

          What it did not mention was that the work that had been leaving was flowing back to the places CCP china had stolen it from, in particular Bangladesh. whose development china brought to a halt decades ago buy Stealing most of its profitable its textile industries.

          What it did dwell on, was that a whole group of countries that had expected to follow this path, would no no longer be able to do so due to Automation by the chinese, in china. And in the west.

          china has stolen much of the world’s manufacturing and intends to keep it.

          china and its Globalised Vampire Corporate allies, mostly originally US based.

          Have Abused Globalisation, to lever themselves to the top of the Pyramid. At the expense of everybody else, and they intend to stay there at the expense of everybody else on the PLANET.

          So the west and in particular the US should be very grateful for the small Number of job’s that are flowing back to it.

          The theory Pushed with Globalisation was that it would rasie the lowest boat steh the most first.

          We laughed and said no it will be abused andag the best to the level of the lowest.

          china and its Globalised Vampire Corporate allies, mostly originally US based. Have proven us correct.

          Automation along with continued job and industry theft by china will continue to hurt the general population of the west.

          That harm Is nothing compared to the future of many undeveloped states who now look at two options become slave states of china and its Corporate allies, or remain undeveloped, for a considerably longer period of time.

          Globalisation in its current form, has, as prophesied, benefited the few not the many, what was not see was the orchestrated abuse of it by china, so that only china gained from it, in any meaningful way.

          Napoleon wrote reference to china ” Beware The Rising Dragon” He was correct.

          The concept of Globalisation is good, what was not done at the begining was to produce 1 rule-book everybody would follow, or not be allowed to play.

          TPP is an attempt at that. The US has dumped TPP, so condemning, a large segment, of at least another generation of American workers, to poverty.

          Proof that Electorates frequently elect the leaders they deserve.

      • FDR Liberal says:


        Apple, et al US headquarted profits in Europe have already been repatriated through their European bank that have U.S. branches.

  5. Raymond C. Rogers says:

    All if this is mind boggling. None of it is happening in the shadows. It feels like an episode of the Twilight Zone.

    On a similar note, I would like to know Wolf- if you could revisit your predictions for the year, and critique which fiscal metrics make sense to you and those that make you scratch your head. I thought of this because I had come across old articles where economists had said the stock markets would climb and gold would fall like a rock- a good many said 600-900. Should we be more concerned that these predictions were half right, as opposed to completely right or completely wrong?

    • Petunia says:

      People are jumping off buildings in New York City, it seems for financial reasons. It’s not a common occurrence there, but lately there have been a few. I personally think this is a bad sign.

  6. nick kelly says:

    Since buying these bonds looks insane, is there any other explanation?
    Could it be that they are denominated in euros and so this is a hedge against dollar weakness? But there must be a safer way to do that than via junk. So maybe it is the dribble of return plus the hedge.

    • Wolf Richter says:

      Corporate bonds (especially from smaller issuers … many of these junk bonds are from smaller issuers) are not easy to sell. There is not a lot of liquidity for each issue, and it might take a while to sell them especially when yields are rising. That’s why they’re not a great currency hedge that you might need to liquidate at a specific time in order to cover the event you hedged against. I would think if you decided to buy bonds as a currency hedge, you’d buy the most liquid bonds (likely government bonds).

  7. cdr says:

    You haven’t seen anything yet.

    First the ECB finances government debt. Then, it adds corporate debt to the shopping list.

    Soon to announce the ECB personal debt buying binge. And, what’s the best way to create inflation (just joking about the inflation, nobody knows why he does this anymore) using personal debt ….. The ECB MasterCard (or VISA) or even just the ECB Card offering negative rates to the best customers (hint … all customers). High credit limits, flexible repayment plan (or skip a payment now and then is OK), and, if you’re a newcomer (Syrian/Libyan refugee) you’re automatically approved.

    • cdr says:

      And don’t forget … it’s a hate crime to leave home without it.

    • Maximus Minimus says:

      MishTalk has just an article: “Central Banks Puzzled as Global Inflation Hits Lowest Level Since 2009”, and a very good explanation, which has already been made here, too.

  8. cdr says:

    “(just joking about the inflation, nobody knows why he does this anymore)”

    Just joking about that. He keeps it up because the EuroZone ceases to exist when he stops. Thanks, Mario.

    Back in 2012, the ‘Euro Debt Crisis’ was also simple rate normalization. The markets were reacting to Euro-Debt excesses and ECB inadequacies caused by incurable design flaws in the overall monetary union. Greece was the icing on the cake, the too long toenail, the wart on the nose, Europe’s halitosis.

    Now, 5 years and trillions of Euros later …. Watch the fun when ECB QE eventually ends. The tulips will become #2 on the list of bad financial scams forevermore. It’s only a matter of time. The end result – unimaginable financial crisis – is a certainty.

  9. Mike R. says:

    The Central Banks can’t end it. This is what the markets have figured out. When the CBs committed to massive QE, they opened a door that could not be closed since the kind of productivity growth that existed in prior decades is over with. Like most human endeavors, the CBs and political leaders have been steering through the rear view mirror.

    It will be social unrest that upsets the apple cart; not monetary policy. They can do this stuff for as long as society holds together.

    • walter map says:

      “It will be social unrest that upsets the apple cart”

      Your overlords (and overladies) have already thought of this.

      You can expect that they will simply lock down the general population. They will then be able to continue on even more merrily than before, no longer encumbered by the cost of having to pretend to please the people any more. In some circles it is believed that circumstances have been deliberately engineered to produce this result. Economic depression under corporate totalitarianism is likely to be permanent. It’s twilight now; soon, darkness falls.

    • Haus-Targaryen says:

      I disagree, in part, with your analysis. We’re dealing with a bit of circular logic here:

      The CBs can hold this together as long as society holds together, and society holds together as long as the CBs can hold this together. What came first — the chicken or the egg?

      I believe our financial (and thus social and political) system(s) is akin to a clown — balancing on a unicycle — spinning a dozen plates on sticks on his arms, his torso, his head, his face, his nose and one of his legs. As long as all the plates keep spinning the clown stays upright. However, as soon as one plate stop spinning, it will wipe out the whole show — and very quickly.

      The question is — what plate stops spinning and where? While I think we all have been very surprised how long they’ve been able to keep this all together — but these people are not omnipotent. They are human and cannot be everywhere all at once. Eventually, somewhere something will happen, whether political, financial and social which is either blow up faster than they can control, or they’ll control it, but the means they control “it” with are inadequate for the problems existing .. e.g., they underestimate the “counter-measures” needed to be taken to offset some event, and by the time they fully understand what is going on and where and how big it is and what they need to do the damage is already done.

      These people have a firm hold on the system. They cannot let go of it, else they might find themselves shot or hung up from a lamp-post dead somewhere. They’re in this for keeps, and this makes me think neither of the above are going to happen.

      The powers that be, in my opinion, are not fanatics. They are highly intelligent, cunning and instead of letting something get out of hand — they will blow the system up themselves so they can control not only in the implosion but the rebirth of the next system.

      Letting a system get out of control is how you lose power — keeping everything in control is how you retain and expand upon it.

      Just my ::2cents::

  10. michael w Earussi says:

    What concerns me about the ECB QE is since the Euro is convertible into dollars doesn’t that mean that no matter how desirous the Fed becomes about ending their own QE won’t we still feel the effects of the Euro version with an eventual increase in inflation?

    • d says:

      To a certain degree.

      Where do you think so much of the money holding up US stock values (Correction Prices) comes from????

      What you need to think about, is what happens if there is an implosion or other correction event in Euroland, to many of those US stock prices, when Euroland has to get out NOW.

      Remember the 1929 wall-street event, was actual triggered, by the collapse, of an Austrian bank.

  11. Dey says:

    You miss the point. These are NOT junk bonds. Draghi has given them an implicit guarantee. Central banks will simply buy them.

  12. TJ Martin says:

    ” Euro Junk Bonds and “Reverse Yankees” Go Nuts ”

    Begging the question ;

    Can anyone name one solitary aspect of anyone’s economy , industry or financial institutions across the entire planet that haven’t gone absolutely bat**** crazy insane ?

    Sigh … in my hardly ever humble opinion .. methinks reality has left the building .. entirely .

    • James Levy says:

      The ability of most people to discern reality may have departed, but reality remains implacably in place.

      • TJ Martin says:

        On this one I’ll gladly be proven wrong : so lets hope you’re right

  13. Sporkfed says:

    So US treasuries will have greater demand driving the yield lower. This all sounds
    deflationary to me. I suppose this allows
    the FED leeway on raising rates. Too high
    a yield sucks dollars from the rest of the world
    and slows the global economy down, right ?
    What a mess .

    • Wolf Richter says:

      We had crazy asset price inflation. We’re going to get asset price deflation. This is not consumer price inflation or deflation.

      • Mike R. says:

        The world economy can’t withstand significant asset price deflation without CB intervention. The whole things comes spiraling down (debt deflationary sprial). That is why assets stay up until they don’t, at which point the CBs step back in with more QE (or something disguised as QE).
        The Fed’s talk about reducing their balance sheet is pure “wizard of ozery”. Sure, maybe 10 billion here, 10 billion there. Nothing significant.

        • nick kelly says:

          The end game of currencies is not unknown territory. The first great experiment in paper money was tried in France in the 17 hundreds.

          John Law, a Scot and would- be- financier, broke out of prison in Scotland and floated his scheme around Europe: ‘I can change paper into gold’

          He finally attracted someone as desperate as himself: the King of France.
          To make a short story, even shorter, he quickly became the head of finance in France and also ran the largest businesses. As more and more of his paper gold was issued, it was necessary to ban the competitors, actual gold and silver.
          The scheme finally collapsed with Law fleeing and most of France wiped out. The episode was a cause of the French Revolution.

          Later came the post- WWI German inflation, where children played with bundles of worthless notes.

          More recently Zimbabwe’s which ended with a hundred billion note.

          These are a few of hundreds of examples. Most currencies ever issued are worthless.

          The Fed is NOT the Wizard of Oz. It can no more defy gravity than the many that have trod the path before it. The Fed wants to avoid their fate and is increasingly motivated to return to normality. As it has told Washington over and over, there are limits to monetary policy. It alone can’t cover Washington’s desire for a military budget the size of the next six countries combined, plus the developed world’s most inefficient and costly medical system ( one sixth of the economy)

          There is a reason the patent office will no longer consider perpetual motion machines.

          I sometimes wonder about the age of commenters.
          In 1979-80 the Fed raised rates 4 percent in less than six months.

      • d says:

        “We had crazy asset price inflation. We’re going to get asset price deflation.”

        Should read:

        We had crazy asset price inflation. We’re must have asset price deflation.

        The question is can/will it be controlled, or will it be a catastrophic implosion.

        It is not “Consumer” Inflation or deflation, but IT WILL, have a huge effect, on consumers, unless, it is very well managed.

  14. John Henderson says:

    Once again thank Mr ?

    • Gershon says:

      The Fed wants to avoid their fate and is increasingly motivated to return to normality.

      There’s no such thing as tapering a Ponzi. Yellen knows this. She also knows that if or when the Fed starts to normalize interest rates or reduce it’s balance sheet, it’s Game Over for the gargantuan asset bubbles and Ponzi markets the Fed’s Keynesian monetary madness have created.

      I think this is only going to end when Yellen and her Fed partners in crime board the Gulfstreams of their oligarch accomplices – the sole beneficiaries of QE-to-Infinity – and flee under cover of darkness to some non-extradition off-shore hidey-hole as the pitchforks and torches close in on Manhattan and The Hamptons.

  15. JT says:

    The “effective yield” is not the right metric to look at. It is not really yield like yield in YTM, and I am not sure how it can be calculated for an index. Anyway, if you look at OAS, which is the spread over risk free rate (in this case it may be Bund, but it may also,but less likely, be the gov bond for that company) , then you will find it is not that crazy. It is still post crisis low, but the lowest happens in 2007.

  16. william says:

    All of this done has been done before in Japan under the covers with different terminology and source of buyers. Inflation doesn’t soar. A zombie economy muddles through year by year with a multi-tier society continually absorbing the wealth of the citizens. There is no revolt or major upheaval. The numbers of poor expand and the numbers of rich expand.

  17. mean chicken says:

    So someone’s going to lose their shirt while someone else makes out like a bandit. Do your DD then skate to where the puck will be and while doing that, send a nice note to central bankers for making possible the greatest wealth transfer heist in human history.

    They’re the best that money can buy!

  18. BeefRancher says:

    Wolf, I recently retired with lump sum retirement option but the retirement annuity option had some underlying assumptions for near term investment return and longer term investment return. They seemed unreasonable when I retired in 2013 at 4% and 7% respectively. If pension funds are invested in the investments you described above or any other dubious investment options there seems to be a large rip in the fabric for a large portion current and future retirees. Could you perhaps do a case study of a company annuity pension plan investment options or does this already exist somewhere? Thanks for making my day every day!

    • Wolf Richter says:

      Well, first of all, congratulation on retiring with some retirement benefits!!

      I generally don’t review or recommend financial products or strategies. That’s a financial advisor’s job. They get paid to do this.

      Just as a generic thought: So far, asset prices have gone up. Pension funds and annuities benefited from this on their books. Bonds issued a few years ago now trade above face value if the company is in good shape. The problem is that bonds are redeemed at face value. And that’s what an institutional investor will eventually get (unless the bond defaults) plus the coupon payments. So the problems for annuities won’t arise until some years from now.

  19. Truth Always says:

    Why not keep cash? What is the rationale for buying low yield junk bonds? And where are institutional or corporate governance officers who should prevent this absurdity?

    • MD says:

      You know the answer to that – they’re in their big houses, whose value is guaranteed to go up due to CB interest rate manipulation. Or they’re driving their brand spanking new Audis, financed by cheap credit enabled by…CB interest rate manipulation.

      It’s alchemy I tells ya – the magic money fairy has arrived and she is showering us with the the unprecedented wealth only cheap credit can provide.

      Who’s going to rain on that parade?

  20. Dominic says:

    This is a simple matter of supply and demand. There are a large number of institutions that have massive amounts of “bubble money” that was printed at the behest of central banks. They want to further grow this money but the market is pushing back.

    I find it amusing that phoney, bubble money with no real ties to production or ‘real stuff’, should command a real interest return?? Only in the short term, never the long term.

    Too much money chasing too few opportunities (remembering that all investment grade bonds in europe have been bought up by the central banks!).

    Your charts show it all, and I think making relative comparisons to treasuries or anything else is meaningless at this point.

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