By Yoruk Bahceli
(Reuters) – Yields on euro area junk-rated bonds have fallen below the bloc’s inflation rate for the first time, a further sign of the scarcity of assets offering investors any real returns.
The 2.3% yield on the ICE (NYSE:) BofA euro high-yield index is now more than 60 basis points below current euro area inflation, which came in at 3% for August on Tuesday.
The move follows a similar drop in U.S. junk bond yields relative to inflation in May and it has turned more negative since.
Junk bonds are the riskiest debt category, including sub-investment grade securities rated BB+ or below.
Real yields — borrowing costs adjusted for inflation — turning negative on such securities was akin to crossing a Rubicon, BofA credit strategists said on Friday.
“If there’s one metric that defines or reflects how much investors need to reach for yield, it is this negative real yield backdrop,” said Barnaby Martin, head of credit strategy at BofA.
“The irony is that even buying high yield debt doesn’t help you beat inflation in Europe at the moment. It really reflects how much the ECB is keeping a lid on fixed income.”
U.S. as well as European inflation is running above target. Though policymakers see the rise as transitory, the concerns it has stoked, alongside uncertainty around the economic outlook, have helped boost demand for inflation-linked bonds, pushing real yields further and further sub-zero.
Euro area real yields, also an indicator of how easy financial conditions are expected to be, fell particularly sharply in July, when the ECB adopted a symmetrical inflation target, meaning it will keep interest rates lower for longer.
Low real yields are boosting equity and credit markets but BofA strategists warned that such trades were at risk from a possible ECB policy error, whereby policy is tightened sooner than expected, driving up real interest rates.
To beat inflation, “your options are to buy things that yield more than 3% now. And that’s really difficult. Even in high yield that limits you to Single Bs, it limits you to Triple Cs”, Martin said, referring to the lower rungs of the junk debt market.
Bonds rated Triple-C — the lowest junk category — are the top performers in fixed income this year, delivering returns of 10%, according to BofA.
Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.