Junk Debt Yielding Under 5%? Yeah That’s Not a Problem

At recent seminars, I have been taking the time to explain the current rate environment, and why rates are so low.I try to detail (without being too granular) the Federal Reserve’s policy of stimulating the economy by explaining both their:

  • overtly communicated goal of decreasing lending costs to spur borrowing and consumption
  • covertly hinted goal of inflating asset prices so that people “feel” richer

The result of this is that people who are conservative savers (that’s many people) are forced to choose between earning less than 1% in a bank account or taking some kind of risk to earn a higher yield. And when the Fed started this policy, if you WERE willing to take risk, you might have earned a decent yield for that risk.

After two years of relentless purchasing by large institutional investors who need yield to fund pension payments and endowment payouts for example, and purchasing by most everyone else, those same yields have shrunk. I had just pointed out last week, at a workshop that one of the popular junk bond exchange traded funds was yielding a bit over 5% – and how that was historically so low for something with that level of risk.

So low and behold, I see this headline from Zero Hedge:

Junk Debt Drops Below 5% Yield For First Time On Record

At this point I am not shocked. But understand that when the riskiest bonds are yielding less than the CD I owned in high school, we’re heading for trouble. At this moment, corporate profit margins are as fat as they’ve even been. Mainly because of automation and the fact that grunt workers are not getting pay raises (this NBC article lays out some recent data). If workers demand higher wages (Bernanke wants “inflation” and a key component is wage costs) these margins will shrink, making it more difficult for companies with small margins to stay profitable (the kind that borrow at high yields because they are risky).

Historical High Yield Default Rates; from The View from the Blue Bridge

And then we’d see the historical pattern of rates rising on debt as the market senses inflation (remember it’s what the Fed wants), increasing junk debt defaults. In other words, these current rates are a product of a perfect environment for corporate profit margins – and perfect never lasts. ┬áThe only problem for savers is, that this trend could continue for a while and if it does, vulnerable savers like retirees will have to choose to keep their principal safe in the bank earning close to ZERO, or take a risk that at some point, may blow up in their face.

I feel sorry for worried savers. Thanks Ben (Bernanke). As long as those large banks can keep depositors at zero and use that money to make loans at 3-6% and earn huge spreads, everything is all right in the world, right Ben?