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ECB’s bond buying pushes ‘junk’ bonds higher

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What's going on?

As the European Central Bank (ECB) continues its huge bond buying program, known as quantitative easing, the yields offered to investors for even the riskiest, so-called ‘junk’ bonds are trading at very low levels. “Yield” is the income return on an investment and in the case of bonds, refers to interest income paid to the investor. Bond yields and prices move inversely; as the price of a bond goes up, its yield goes down.

What does this mean?

Although the ECB is not currently buying bonds issued by private companies, it is buying a huge amount of government bonds, which has pushed those yields to extremely low, and even negative yields. Investors then focus more on buying bonds issued by private companies, and as they search for attractive yields, they are forced further down the risk spectrum, such that they are buying bonds from even the riskiest companies in the hopes of achieving attractive enough yields.

Why should I care?

It is quite possible that the seeds of the next financial crises are being sown by the historically low interest rates we are now experiencing. This could become painfully apparent in the “high-yield” portion of the corporate bond market, if these very risky companies are unable to pay back their obligations. A crisis in confidence in the high-yield bond market, possibly exacerbated by the illiquid nature of the market itself, could be a threat to the prices of stocks globally and is a risk that all investors should remain wary of.
Originally posted as part of the Finimize daily email.

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