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UBS Says Junk Bond Bubble Just a Slowdown Away From Popping 

April 13, 2016

Michelle Davis, Bloomberg

Investors that lend to U.S. junk-rated companies aren’t being compensated for the looming credit shakeout that could push defaults to record highs, according to UBS Group AG credit strategists Matthew Mish and Stephen Caprio.

"There is a bubble in speculative grade credit," Mish and Caprio wrote in an April 11 note. "Simply put, clients were not being compensated for the credit risk."

A slowdown in U.S. growth could cause the bubble to pop, stressing the lower-quality companies that constitute almost half of the universe of speculative-grade bonds and loans. Investors that crowded into the debt could suffer massive losses, Caprio said in a phone interview. The same strategists put the probability of a U.S. recession this year at 23 percent, according to a March 3 note.

Even as credit spreads tightened in the second half of the year, recovery rates -- or how much of their principal investors get back when there’s a default -- have slipped, JPMorgan Chase & Co. strategists led by Peter Acciavatti wrote in a March 31 note. The measure for high-yield bonds during the last 12 months was 22.8 percent, down from 25.2 percent at the end of last year and well below the 25-year annual average of 41.4 percent, the strategists wrote. Read more

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