The European Central Bank has been buying up corporate bonds.
This is a major concern to some who want the markets. The prevailing view is that the Central Bank's actions could be distorting the value of some of these companies.
“You could have a bunch of walking-zombie companies and you don’t even know it,” explained Mary Callahan Erdoes, CEO of JPMorgan Asset Management, on Wednesday at the Delivering Alpha Conference in New York. “That’s a super dangerous place to be,” she said.
The ECB is doing this in an effort to drive down corporate rates to near zero. Many bonds now have negative yields which means that someone has to be desperate to purchase this. With inflation moving upward, many are taking on the bonds in spite of the yields simply to cover the move in inflation.
At the end of the year, the ECB plans on exiting these purchases. This is really alarming to many since nobody knows how investors will react. What happens if they wake up only to realize the companies they are holding are worthless? At the moment, no credit risk is being priced in at all. Essentially, all bonds are being priced the same.
“You’re equally rewarding the A-plus student and the student who’s doing no homework and is just showing up,” Erdoes said at the conference, as reported by Bloomberg. “That’s a super dangerous place to be, because when that gets pulled back, and the markets have to sort of figure out the good from the bad, and you have real-money buyers in there, as opposed to the governments, then you start to do your homework and you figure out, ‘This is not all the same.’”
https://wolfstreet.com/2018/07/18/risk-pricing-central-bank-bond-buying/
Investors tend to get lulled into a sense of complancy. For most of the last decade, Central Banks around the world stepped in to counter any negative effects. This protected investors from operating in a risky manner. Again, the ECB pulling the rug out from under the corporate bond buying could see these assets deflate like a balloon.
When complancy takes over due to artificial market means, it can get ugly once those means are removed. The United States is potentially faced with a similar situation as the Fed looks to unwind the balance sheet and raise interest rate.
With the Central Banks there to bail out markets, there is no need to price risk in....until there is.
As the banks step aside, the investors might find themselves without any backstop.