European Junk Bonds Now Yield More Than U.S. Treasuries

On Friday, the small caps outperformed the mega caps as the Russell 2000 – RUT was up 0.40%, while the Dow was down 0.43%. In the midst of this middling action, the JNK high yield bond index was down 0.05% and the HYG high yield bond index was down 0.03%. The chart below shows the recent action in the European high yield bond index. It has been selling off more sharply than American junk bonds in the past few weeks. As you can see, the 6 week stretch where the European high yield bonds had lower yields than U.S. treasuries has ended with a spike in European junk bond yields. Obviously, that was a weird stretch because U.S. treasuries have a AA+ rating from S&P500 and a AAA rating from Fitch while European junk debt consists of highly risky corporate bonds.

I speculate that the ECB’s policy of buying corporate bonds has pushed European junk bond yields lower than the free market would price them. These low yields allow companies that would probably go out of business to stay in business. These firms are known as zombies. They have the most prevalence in Italy where about 20% of firms are zombies. The ECB pulling back its purchases in 2018 might have catalyzed this selloff. If that’s the case, this selloff is only just getting started because the ECB will end the program at the end of 2018.

Getting back to American high yield bonds, the JNK ETF had one of the largest single day outflows, but the HYG didn’t have a similar sized selloff that day. The chart below shows the severity of the JNK outflows. As you can see, this was the largest outflow in at least the past few years. It was a weird outflow because it didn’t lead to much of a decline in the JNK probably because it was short lived.

While the HYG didn’t have big outflows in that one day of trading where the JNK had massive outflows, the HYG did have a big week of outflows. As you can see from the chart below, the high yield ETFs and mutual funds had a combined $4.43 billion in outflows. These were the largest outflows in the past 3 years and 2 months. This was the 3rd largest week of outflows ever. The second largest was in August 2014. The HYG ETF had $1.43 billion in outflows from last month and the JNK had $934 million in outflows.