When central banks distort the markets, risk disappears from view.
“You could have a bunch of walking-zombie companies and you don’t even know it,” explained Mary Callahan Erdoes, CEO of JPMorgan Asset Management, on Wednesday at the Delivering Alpha Conference in New York. “That’s a super dangerous place to be,” she said.
She was talking about the effects of the ECB’s bond buying program as part of a broader warning that investors are no longer seeing risks.
The ECB has been buying corporate bonds, among other things, in an explicit effort to distort the bond market and drive corporate bond yields to near zero. At the peak of the frenzy last fall, the average euro junk-bond yield fell to 2.08% — though it has risen since. These are bonds with an appreciable risk of default. But the yield was barely enough to cover inflation (currently 2.0%). Credit risk wasn’t priced in at all.
The bond-buying binge has created a universe of bonds with negative yields, and desperate investors who’ll take any risk without compensation just to cover inflation. This desperation supplies fresh money to burn to even the riskiest zombie companies.
Companies have relentlessly taken advantage of this investor desperation. The amount of corporate euro bonds outstanding has surged by about 45% over the past three years, to €1.5 trillion ($1.75 trillion), including record euro-bonds issued by American junk-rated companies.
When credit risk is not being priced at all – when it’s free – this most important gauge of the credit market is worthless.
“You’re equally rewarding the A-plus student and the student who’s doing no homework and is just showing up,” Erdoes said at the conference, as reported by Bloomberg.
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