According To Santelli the 30 Year Aution Went Horrible…Plus a Story on Junk Bonds

Beware of the recent junk bond rally

By Shannon D. Harrington

May 7 (Bloomberg) — Junk-bond investors who have spurred the biggest rally on record are getting ahead of the recovery as the rate of company failures is about to surge, according to debt strategists from at least six Wall Street firms.

Bonds rated CCC and lower — those ranked most likely to default by Standard & Poor’s, Moody’s Investors Service and Fitch ratings –have gained 39 percent since March 9, compared with 14 percent for those rated BB, or just below investment- grade, according to Merrill Lynch & Co. index data. The bonds helped spur the biggest junk rally since Michael Milken helped create a market for the securities in the 1980s.

“Champagne might be a little premature,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said in a Bloomberg Television interview. “You’re still facing the biggest distressed default cycle that we’ve ever seen.”

Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3 percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance.

The amount bondholders are recovering after default is also shrinking as access to loans that fund companies through bankruptcies remains tight. Recovery rates for defaulted senior unsecured bonds since Dec. 1 have averaged 9 percent, according to Goldman Sachs Group Inc. strategists led by Charles Himmelberg in New York, below the firm’s forecast of 12.5 percent for recoveries this year.

‘Ahead of Itself’

“The high-yield bond market is a little ahead of itself,” Tony James, president of Blackstone Group LP, the world’s largest private-equity firm, said on a May 6 conference call with reporters.

After fleeing all but the safest government debt last year following the failure of Lehman Brothers Holdings Inc. and a deepening global recession, investors in March regained risk appetites amid signs that the economy may have bottomed, with Federal Reserve Chairman Ben S. Bernanke telling CBS Corp.’s “60 Minutes” on March 15 that he was seeing “green shoots” in some financial markets.

“We’ve seen just enough macro stabilization that people were willing to take down the probability of a Great Depression,” Himmelberg of Goldman Sachs said in an interview.

Investors betting that high default rates were already priced into junk bonds injected $1.79 billion into U.S. high- yield bond funds in the four weeks ended April 29, according to AMG Data of Arcata, California.

As the market rallied, “I think investors felt like they had no choice but to pile in,” Himmelberg said. “Otherwise they were going to get left behind and underperform their benchmarks.”

Spurring Sales

That helped spur sales of new junk-rated debt. Companies have sold $6.9 billion of sub-investment grade debt this week, the most since the week ended June 27, when high-yield, high- risk borrowers raised $9.9 billion, according to data compiled by Bloomberg.

Analysts at Morgan Stanley, Goldman Sachs, Barclays Plc, Bank of America Corp., JPMorgan Chase & Co. and Deutsche Bank AG have all cautioned during the past two weeks that the exuberance may have become overheated. They’ve suggested investors use the rebound to reduce their exposure to lower-rated high-yield companies.

“What investors are missing is the growth coming out of this very hard recession is going to be the most tepid growth we’ve ever experienced,” Morgan Stanley’s Peters said.

Yields and Defaults

At the end of April, yield premiums that investors demand to hold high-yield bonds rather than government notes were implying a default rate lower than that forecast by Moody’s according to Jim Reid, head of fundamental credit strategy at Deutsche Bank in London.

After adjusting for losses from defaults and subtracting the yields investors can earn from owning government debt, excess returns from bonds in the Markit iBoxx investment-grade index was estimated to be 4.3 percent in the U.S. as of April 30, Goldman Sachs strategists said in a May 1 note. For iBoxx indexes of sub-investment grade bonds, the excess returns were estimated at 2 percent.

In Europe, a credit-default swaps index of mostly high- yield companies was estimated to lose 1.5 percent when subtracting expected default losses and yields from five-year government bonds.

“What’s been surprising to me is how aggressively the credit market was willing to pay for the still-early signs of a turning point,” Himmelberg said.

Capital Needs

Bank of America, Citigroup Inc., Wells Fargo & Co., Morgan Stanley and GMAC LLC are among the top 19 banks in the U.S. judged by U.S. regulators to need additional capital as a buffer if the economy were to deteriorate, according to people familiar with stress tests conducted by the government.

The Labor Department this week will report U.S. employers cut 600,000 jobs in April, according to the average estimate of 69 economists surveyed by Bloomberg. The decline would add to more than 5 million jobs lost in the U.S. since the end of 2007.

To emerge from the recession, the U.S. economy will require further government stimulus, International Monetary Fund Chief Economist Kenneth Rogoff said in a Bloomberg Television interview.

Equity investors also have joined in the rally for high- yield companies.

Companies with bonds trading at the highest yields and making up the least amount of new debt issued in March and April saw a 95 percent jump in their share price from March 9 to April 30, according to Morgan Stanley data. In comparison, shares of companies that sold the bulk of debt during that period rose 17 percent.

“This is a very dangerous bet at this time in the economic cycle,” Morgan Stanley credit strategist Rizwan Hussain told investors in a May 4 conference call. “Capital access is still tenuous.”