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Junk bonds are back! Thirst for yield returns

Friday, 26 Jul 2013 | 10:18 AM ET
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After talk of a "great rotation" into stocks, Fed "tapering" fears and an "unprecedented" $80 billion pulled from bond funds, it now appears that the credit market has shifted into a higher gear, according to Bank of America Merrill Lynch, which pointed to "red hot" inflows into European high-yield bonds.

"Bond inflows were huge in Europe over the last week, a sign that the central bank dovishness of late is again driving a thirst for yield. High-yield credit inflows were the largest ever in dollar amount, and the highest in percentage terms since September last year," a team of analysts at BoAML headed by Michael Hartnett, said in a research note on Friday.

(Read more: Municipal bonds 'hemorrhage' $1.2 billion on Detroit fears)

High-yield (HY) or junk debt refers to bonds that carry a rating of 'BB' or lower from Standard & Poor's or 'Ba' or below from Moody's. They have a higher risk of default compared to investment-grade debt.

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The global sell-off in bonds began on May 22 after the minutes of the Fed's policy meeting signaled that its bond-buying program—which has boosted global bond prices—could soon be pared back. Since then, however, dovish comments by Federal Reserve Chairman Ben Bernanke have calmed bond markets.

(Read more: Global Bond Spike Not All Bad, Here's Who Benefits)

Bonds have rallied to an even greater extent in Europe, especially in high-yield debt, as money has flowed back into the space. Almost half of June's $9.7 billion outflow from high-yield funds have now been reversed, BoAML said, adding that last week's $2.3 billion inflow into European high-yield debt was the highest dollar inflow on record.

"The credit market has shifted into a higher gear, with credit investors not only taking down a record amount of issuance, but also reaching for greater risk," Brian Reynolds, chief market strategist at Rosenblatt Securities said in a research note on Thursday.

"When the dust settles on the panic, [bond investors] begin buying aggressively again in their quest to make 7.5 percent for their pension fund clients. This process is happening right on schedule."

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