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Junk bond default rates have plunged

Today Moody's announced that "the trailing 12-month global speculative-grade default rate dropped to 3.3% in November 2010. A year ago, the global default rate stood much higher at 13.6%." Moreover, Moody's is now forecasting that this same default rate "will fall to 2.9% by the end of this year before declining further to 1.8% by November 2011." "Measured on a dollar volume basis, the global speculative-grade bond default rate remained unchanged at 1.4% from October to November. Last year, the global dollar-weighted default rate was noticeably higher at 19.6% in November 2010."

The improvement in just the past year is remarkable: "A total of seven Moody's-rate corporate debt issuers have defaulted in November, which sends the year-to-date default count to 52. In comparison, a total of 257 defaults were recorded in the comparable time period last year."

Here's the reason behind the improvement: "Corporate defaults are falling as profits surge, the economy recovers and debt markets allow even the riskiest borrowers to raise record amounts of cash. Junk-rated companies have sold $97.8 billion of bonds globally since September, putting issuance on pace to beat the record $99.8 billion raised in the third quarter, according to data compiled by Bloomberg."

The above chart shows the average yield on junk bonds, currently 8.2%. The dramatic decline from the unheard-of-before peak of 25% is simply breathtaking. This improvement also owes much to accommodative monetary policies all around the world. Easy money is a debtor's best friend, as they say.

This next chart shows the spread on high-yield CDS, which also shows dramatic improvement—and, more importantly, room for more, especially since default rates continue to decline. To date, the generous spreads on junk bonds have helped insulate this market from the rather dramatic increase in Treasury yields. Since the end of August, when QE2 was first floated, 10-yr Treasury yields are up over 60 bps, yet junk bond yields have fallen by about 30 bps.

Even if 10-yr yields rise further—as I expect they will, since the economy is continuing to grow and Obama's long-awaited decision to go bipartisan on the issue of taxes should impart some genuine growth stimulus to the economy, and forward-looking inflation expectations have risen from 2% in August to almost 3% today—I note that junk yields traded around current levels back in the first half of 2007, when 10-yr Treasury yields were over 150 bps higher than they are today. To pass up 8% yields on junk bonds in favor of cash yielding almost zero is equivalent to saying that all h*ell is going to break loose at any moment.

Full disclosure: I am long TBT and long various high-yield mutual funds at the time of this writing.

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