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Junk Bonds Start to Lose Their Luster

“A selloff in junk bonds is fueling fears among some investors that the best days of the bond boom may be in the past.

The spread between the yields on low-rated corporate debt and comparable U.S. Treasurys jumped 0.18 percentage point Wednesday to 4.39 points, its highest level since April.

The action is unusual because junk bonds tend to outperform higher-rated debt such as Treasurys and high-rated corporate bonds when interest rates rise. The yield on the benchmark 10-year Treasury note has risen 0.5 percentage point over the past month.

The selloff of junk bonds this week indicates that many investors who have been pouring money into riskier debt were caught off guard by the pace of the past month’s rise in Treasury yields. Investors who moved into riskier asset classes such as junk bonds because of a lack of high-yielding alternatives may be pulling away from the assets as they position themselves for an eventual return to higher interest rates, which have been held near record lows by robust central-bank support programs, observers said.

“The salad days for risk assets might be drawing to a close,” said Thomas Byrne, director of fixed income at Wealth Strategies & Management LLC. He said the selloff has been driven by investors fleeing from bonds amid chatter that the Federal Reserve might soon begin reducing the scale of its $85 billion monthly bond-purchase program known as quantitative easing.

Typically, the spread between Treasurys and junk bonds narrows as Treasury yields rise, as investors bet that an improving economy will mean fewer defaults on bonds issued by low-rated companies.

But in the past four weeks, not only did premiums on junk bonds not improve much, they recently worsened. Some see that break in the pattern as a potential inflection point in the debt markets…..”

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