Risk for high yield bonds are increasing?

There could be a bubble brewing. With High yield bond spread reaching such a low degree, its time to be abit cautious.

Investors are buying bonds from the lowest credit-quality issuers without restraint, according to Citigroup Inc.

Yields on high-yield, high-risk debt have narrowed by 80 basis points relative to benchmark rates in the past two weeks, Citigroup analysts John Fenn and Jason Shoup wrote in a Sept. 18 report. Last week, 13 companies, including casino owner MGM Mirage and video chain Blockbuster Inc., sold more than $6.5 billion of bonds, they wrote.

“These are the kinds of dynamics that cause strategists to wake up in the middle of the night and go for a long run,” the New York-based analysts wrote. “We understand investors are not supposed to fight the cash, but this is starting to become a bit ridiculous.”

Issuers have sold $98.6 billion of junk bonds this year, a 62 percent increase over the same period in 2008, according to data compiled by Bloomberg, as credit markets have thawed and the economy shows signs of emerging from the longest recession in seven decades.

There have been two troubling developments in new bond sales, the Citigroup analysts wrote.

“Deals are being priced more aggressively and there has been a notable move down in credit,” they said.

Junk spreads have narrowed 114 basis points this month to 798 basis points as of Sept. 18, according to Merrill Lynch & Co. index data.

Lower Default Rate

The debt gained 46.8 percent this year, after losing 26.4 percent in all of 2008, Merrill index data show.

High-yield debt is rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service. A basis point is 0.01 percentage point.

Strategists are predicting fewer companies will default on debt next year as the economic recovery gains momentum. Junk- rated issuers will fail to make debt payments at a rate of 9 percent this year, with the ratio falling to 4 percent next year, JPMorgan Chase & Co. strategists led by Peter Acciavatti said in a Sept. 18 report.

The New York-based bank had previously said companies would fail to make payments next year at a rate of 7 percent.

The availability of cash in the corporate bond market is increasing as an index of liquidity-stress improved for a fifth straight month, Moody’s Investors Service said today. Moody’s said Sept. 9 that it expects the U.S. default rate to fall to 4.1 percent by August 2010 from 13.2 percent next quarter and 12.2 percent last month. In July, the New York-based ratings company forecast the rate to decline to 5 percent by June.

“Remarkably, at a time when investors are worrying, the economic data are improving rapidly and company fundamentals ought to follow,” the Citigroup analysts wrote.

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