Yellen Warning Falls on Deaf Ears and Today’s Other Top Stories

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Janet Yellen appeared before the Senate Budget Committee this week, where she agreed that the U.S. economy is on the mend but reaffirmed the central bank is prepared to act should it falter.

None of which came as much of a surprise to analysts who are expecting the Fed to continue with the process of reducing its monthly bond buying programme known as quantitative easing, in which billions of dollars of bonds are purchased in an attempt to keep long-term interest rates low and stimulate growth.

But in a departure from normal Fed rhetoric, Yellen specifically pointed to the growing issuance of leveraged loans and high-yield bonds, as well as a loosening of underwriting standards.

For a Fed chair to mention specific asset classes is highly unusual and points to mounting concerns within the Fed about loosening credit markets.

“Mentioning high-yield and leveraged loans in testimony now sends a subtle signal to the financial community: ‘We are watching, don’t get too excited’,” said Oleg Melentyev, head of US credit strategy at Deutsche Bank.

But despite her best efforts it appears Yellen’s remarks appear to have fallen on deaf ears.

Just one day after her comments, the U.S. high-yield market printed more volume than in all of the previous week.

“There is indeed a search for yield, but that’s been happening for a while,” one senior investment banker told IFR. “And other Fed speakers have mentioned the risks of this behaviour, so I am not sure what these latest remarks are supposed to indicate. They have never said we should stop doing deals.”

So bankers are willfully choosing to ignore Yellen’s comments, because there is a lot of money to be made trading in this type of debt. In fact several bankers told IFR that, amid the current red-hot demand in the market, banks are not in a position to make a moral judgment about structural risks.

“If we don’t do those deals, someone else will and we would be missing out on important fee-earning mandates,” said one. “Structures are getting riskier with each day, but there is sufficient appetite for these trades to get done.”

The desperate search for yield has led private investors into some pretty dodgy neighborhoods. Junk bonds and catastrophe bonds have all seen massive inflows of capital in the last eighteen months or so.

This influx of capital has meant yields have plummeted to the point where investors are not being adequately rewarded for the amount of risk they are taking. Risk reward profiles are not something most private investors concern themselves with. They typically look at headline yields only.

In this case Yellen is doing the right thing by making these comments in public. Because if the banks are not going to worry about selling you high risk debt. Maybe you should.


Todays Other Top Stories

Municipal Bonds

Bloomberg: – Creative ways to fill the nation’s potholes. – Oh, dear. Another crisis. The Highway Trust Fund, which pays for the bulk of federal road and transit spending, is on the verge of insolvency. It faces a shortfall of roughly $63 billion over the next four years and may soon be unable to meet its obligations.

Bond Buyer: – Strategists concerned muni investors can’t manage tobacco bonds’ risk. – Tobacco bonds have lured investors with some of the highest returns in the muni market this year, raising concern among strategists that traditional municipal bond investors’ are taking on too much risk.

Bloomberg: – Munis defy sell calls with biggest fund inflows in 16 months. – Yields in the $3.7 trillion municipal market are the lowest in 11 months amid the most demand for tax-exempt state and local debt since January 2013.

ETF.com: – Daily ETF watch: Active muni ETF coming. – First Trust Advisors plans on May 15 to launch the First Trust Managed Municipal ETF (FMB), an actively managed fund that will target investment-grade muni bonds. Muni debt is an asset class that offers investors access to improved finances of towns, cities and states as well as attractive taxable equivalent yields relative to other fixed-income securities.

Bloomberg: – No-bid sales drop as Philadelphia chooses auctions. – U.S. states and cities are selling bonds via competitive bidding at the fastest pace in more than a decade as officials strive to cut costs almost five years after the recession.



LearnBonds: – A guide to utility bonds. – A utility bond is a type of municipal bond that is issued to finance the construction of public utility projects, such as water systems, sewer systems, electrical plants and various public projects. The issuer of a utility bond receives a cash payment at the time of issuance in exchange for a promise to repay the bond holder over time.


Treasury Bonds

Income Investing: – ‘Nouveau bond bulls’ suddenly in abundance – Tchir. – The persistent and unexpected strength of long-dated Treasury bonds has given rise to a host of strategists looking to explain that strength and why it could persist. Peter Tchir of Brean Capital today casts a skeptical eye on this crowd. “I have seen a surge in the number of people writing or talking about why the bond market can keep going up,” Tchir writes today. “I am not sure where all these nouveau bond bulls were ahead of last week’s FOMC meeting, but they are apparently everywhere now.”

Bloomberg: – Wall Street bond traders could use an espresso. – U.S. government-debt dealers just had the slowest April since 2010 even though the market has ballooned by about 37 percent since then, Federal Reserve data show. Prices are barely budging, with volatility plunging toward record lows. The debt just won’t drop in value, regardless of how many investors put on bearish wagers in anticipation of rising interest rates.

Townhall Finance: – Surprise profits in surprising markets. – Who would have predicted that long-term Treasury bonds would be so strong this year, with the value of the iShares 20+ Year Treasury Bond ETF (TLT) up more than 11% year to date?

Bloomberg:  – Treasury yield curve steepens most in six months on Fed outlook. – The Treasury market’s yield curve steepened this week by the most since November after Federal Reserve Chair Janet Yellen eased investor concern that policy makers would accelerate interest-rate increases.

Reuters: – Yellen comments don’t get much market traction. – Janet Yellen’s first public comments about market risks this week were largely shrugged off by the market itself, where the hunt for yield doesn’t look to be going away anytime soon.

CNN: – Treasurys mostly flat after Thursday’s gains. – U.S. bonds held steady on Friday, holding the previous day’s gains amid a broad rally in government debt sparked by safe-haven buying.


High Yield Bonds

FT: – Investor dash for trash feeds M&A surge. – An important reason why corporate bond markets have rallied this year – pushing prices into what many investors fear is bubble territory – is that corporate treasurers have remained cautious. They have used ever lower borrowing costs largely to refinance existing debt more efficiently; company default rates are still exceptionally low.

Forbes: – Reasons to fear and love junk bonds. – It has become a major parlor game amongst financial professionals to discuss whether high yield bonds are currently in a bubble.  Across the various credit classes within high yield, junk bonds returned almost 7.5% in 2013.  So far, in 2014 junk bonds have continued to perform very well.

Forbes: – Cash outflow from ETFs dents high yield bond fund inflow. – Retail-cash flows for high-yield funds reversed direction for a fifth consecutive week, with a net $368 million inflow in the week ended May 7, according to Lipper. The inflow cut away at the prior week’s $631 million outflow and the flip-flop readings over five weeks net out to positive $404 million.

Focus on Funds: – Junk bond ETFs: Punching above their weight. – As Wall Street dealers retreat from the bond market, exchange-traded funds are expanding – even, to some degree, taking the retreating dealers’ place. Nowhere is the trend clearer than in the $1.3 trillion market for junk bonds, where fast-trading ETFs are punching well above their $36 billion weight, a report this week from Fitch Ratings confirms.


Emerging Markets

George Bijak: – Emerging markets at risk. – The massive post-GFC Quantitative Easing (QE) in the US, EU and now in Japan has repaired the global banking system’s balance sheet. Debt of various qualities, worth trillions of dollars, was moved from struggling banks to the central banks at book value where it is likely to run out to maturity or roll over.

Julie Hammond CFA: – Emerging Market Debt: An asset class coming of age. – When Kristin Ceva, CFA, managing principal and head of emerging market (EM) debt strategies at Payden & Rygel, began analyzing emerging market bonds in the early 1990s, there were 14 countries in the dollar-pay index. Today there are more than sixty countries in the index, with $1 trillion in dollar-pay bonds, $1.1 trillion in EM corporates, and $7.9 trillion in local currency debt.

Stockhouse: – Some institutional investors have looked to add emerging markets debt exposure while retail investors have reduced, says market vectors’ Fran Rodilosso. – Some institutional investors are starting to wade back into emerging market debt. At the same time, retail investors appear to have reduced their allocations over the past 12 months, and still seem to be generally avoiding the asset class, according to Fran Rodilosso, fixed income portfolio manager for Market Vectors ETFs.

Reuters: – Shrugging off tapering, falling emerging debt yields breach key level. –  The premium which emerging dollar bonds hold over U.S. yields has shrunk to a level not seen since May 2013 when the Federal Reserve flagged plans to taper its stimulus programme and triggered a sell-off in the risky asset class.


Catastrophe Bonds

FT: – Why Buffett is steering clear of catastrophe bonds. – QE is leaving some investors exposed to natural disasters in the reinsurance market.


Investment Strategy

Michael Fabian: – How this top bond fund skirts interest rate fears. – A strategy we have been implementing for clients in our Strategic Income Portfolio during the last several years to take some of the guess work out of interest rate fluctuations is tossing aside traditional fixed-income investments in lieu of multi-sector or strategic income funds.

Larry Swedroe: – Should you include international bonds in your portfolio? – Diversification of risk is an extremely important part of a prudent strategy. For the average investor seeking to further mitigate volatility in a diversified portfolio, foreign bonds can play such a role.

MarketWatch: – How to gauge bond fund losses before rates rise. – Financial markets are full of uncertainty, but how rising rates affect bond prices isn’t all that mysterious. In this week’s featured question, we explore how to estimate the damage rising rates may inflict on bond holdings.


Bond Funds

Advisor Shares: – Overview of the fixed income market. – It is important to gain an understanding of the fixed income marketplace and the investment options within it.

FT: – Bond funds flows batter equities. – Ding dong, the great rotation is dead? That may be premature, but bond fund flows clobbered equity funds last week, with the former seeing $9bn of inflows and the latter $9.3bn of withdrawals – the most since February.


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