The end of the year has arrived but the storm in the risky assets did not get any relief. The panics that started with the end of the QE asset buying took an end in the stock market with the statement of being patient with the rate hikes but the interest rates of the junk bond with under investment grade credit rating are soaring.
The panic regarding the Fed's interest rate hikes and the very serious decline in energy prices in the market where the US has a size in excess of 2 trillion USD and the size of the Emerging countries' stock estimated as being between 600 billion USD and 1.1 trillion USD, causes the threat of a serious bankruptcy and default. Even if there isn't any threat of default in some cases, it will become very expensive to issue new bonds in the coming months.
Following Yellen's warning in August regarding the over-valuation, the weather suddenly changed in the junk bonds that were the brightest asset class in 2014. The investors realized that the returns had dropped significantly and thus started to shun the new issues. At the end of November, the annual return on these assets had already become nil.
The drop in energy prices, a couple of minor default cases in the Chinese bond market and the rise in bond yields in the 2-year bonds in the US were also one of the straws that broke the backbone of the market. Currently, while the return in the energy companies' bonds have risen to double digits, the spreads in the others, that is the interest rate difference with the US government securities in peer-term, began to expand as the market indicated that the default risk was on the rise.
Widening of the spreads does not indicate the deterioration of the financial condition of the company; on the contrary, as the energy constitutes an input for all the companies, their costs are going to drop significantly. However, the liquidity is tight in the markets and the existing funds have started to move to the private sector bonds with high credit rating and to the US government securities.
Many companies had issued new securities under the assumption that the maturing bonds would be rolled-over. If they are forced to redeem them due to the rise of the interest rates, they may default. And the defaults could put into trouble the leveraged funds that hold them in their portfolio. This wave of defaults could well spread to the stock market.
The risks regarding the raising of the interest rates by the Fed by mid-2015 and the harsh decrease in the available foreign currency reserves in Russia's central bank could reach proportions that could ignite a panic in the financial markets. And the spark that could set the fire on may come from China. China is the number one issuer through Hong Kong in the Emerging Economies section of this asset group and is also the most risky country. In particular, the situation of companies operating in the housing sector is faltering. Currently, China's private bonds are standing tight based on the assumption that the Chinese government will not allow the bankruptcy of the debtor companies. In the event that Beijing changes its attitude, a real panic could start in the junk bond market and could spread to all risky assets...
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