High Yield Bonds – The collapse in the price of oil and natural gas over the last year and half means a lot more than just lower gasoline prices and lower stock prices for firms in the energy sector. Dramatically lower oil prices leads to many other economic ramifications, from lower production and shipping costs for manufacturers and retailers to a significant weakening of the high-yield or “junk bond” market.

A December 29th report from FactSet Insight highlights that the recent rate hike by the Fed did not really upset the beleaguered junk bond markets as much as expected.

FactSet’s Sara Potter explains that the Fed managed to telegraph the rate hike sufficiently that it was already pretty much built into the prices of high-yield bonds. “However, since the rate hike announcement, the high-yield market appears to have stabilized. The clear telegraphing of the imminent rate hike along with the explicit language in the Federal Open Market Committee (FOMC) announcement that future rate increases were likely to be implemented on a “gradual” basis helped to calm the high yield market.”

High Yield Bonds
High Yield Bonds

The energy sector is a major drag on High Yield Bonds

In reality, higher interest rates reflect an improving economy, so it’s at least reasonable to argue that the overall outlook for high-yield bonds has improved, but clearly the energy segment of the market is still in bad shape and higher interest rates certainly don’t help. Crude oil prices hit their lowest levels in more than 11 years last week with West Texas Intermediate crude slipping under $35 per barrel and Brent crude at $37 per barrel. Natural gas plummeted to a 14-year low of $1.75 per million BTUs with mild winter forecasts leading to oversupply concerns

By the same token, analysts are not projecting much of a rebound in energy prices over the next couple of years. The analysts consensus for WTI crude is an average $53 per barrel in 2016 and $60 per barrel in 2017, with Brent crude at an average of $57 per barrel in 2016 and $65 per barrel in 2017. Natural gas is projected at $2.87 per million BTUs in 2016 and $3.21 in 2017. However, no one can predict what oil prices will do going forward – but was is clear is that right now oil prices are hurting many bonds (and others).

Potter concludes that the ongoing decline in the junk bond markets is largely due to the disaster in the energy sector. “It is clear that the weakness in the high yield market is mainly due to energy-related securities. While the total market is down 2.5% from two years ago according to the Bank of America index, the Bank of America Merrill Lynch U.S. High Yield Energy index is down by more than 30%.”