A Federal Reserve governor is joining those warning that junk-debt investors are poised for losses, while his institution’s policies spur them to keep buying the debt.
Yields on a record 38 percent of the $1.1 trillion of notes sold by the neediest U.S. borrowers were trading below the 10- year average rate for investment-grade debentures last month, Barclays Plc data show. Investors poured a record $1.3 billion into U.S. leveraged loan funds last week as covenants on the debt weaken the most ever.
The central bank’s policy of keeping benchmark borrowing costs at about zero for a fifth year is pushing investors into riskier debt, even as Fed Governor Jeremy Stein warns that the market for speculative-grade debt may be overheating. While U.S. prosecutors are suing Standard & Poor’s for deliberately failing to provide warnings against losses on collateralized debt obligations before the credit crisis, the government’s stimulus is fueling demand for similar products now.
“No matter how loud the chorus gets that this is crazy, the bulls are going to continue to run because there’s nowhere else to put money in fixed income,” said David Tawil, the co- founder of Maglan Capital LP, a distressed-debt hedge fund that manages about $50 million. “If I’m saying now that the deals are getting laughable, if things don’t change, six months from now the deals are going to be stupid.”
Banks could be walloped by a bursting bond bubble, cautions Federal Reserve Governor Jeremy Stein.
Banks, Stein warned in a recent speech in St. Louis, may be especially as risk from loses because they typically hold a high portion of long-term bonds, which suffer the most when interest rates rise.
“We have the Japanese central bank printing money and the European, you got all of central banks printing money,’’ he said.
“It’s a vicious cycle and it is … This is all insanity. No sound person in his sound mind would say, this is the way to run things. Of course, it’s going to lead to more — we already have inflation. But the government says we don’t have inflation. If you shop, you know that there’s inflation.’’
The Federal Reserve’s massive easing program has been a disaster, says Steve Forbes, chairman of Forbes Media.
“The Fed is addicted to failed policies,” he says in an exclusive interview with Newsmax TV.
Quantitative easing is a waste of money that does “more harm than good,” Forbes says. “It does not go to industries and businesses of the future. … No wonder the economy is stagnating.”
Schiff has been a consistent critic of the Federal Reserve’s massive easing program.
“The Fed knows that the U.S. economy is not recovering,” he noted. “It simply is being kept from collapse by artificially low interest rates and quantitative easing. As that support goes, the economy will implode.”
Gross domestic product (GDP) shrank 0.1 percent in the fourth quarter.
“We’re broke. We owe trillions. Look at our budget deficit, look at the debt-to-GDP [ratio], the unfunded liabilities,” Schiff added. “If we were in the eurozone, they would kick us out.