jpy : may move upward on credit downgrades risks

(wed, 6 may 2020). the japanese yen may extend its gains versus its peers if stress in the market for collateralized loan obligations (clos) is amplified in the current environment. the almost $700 billion market is the biggest part of the broader $1.2 trillion market for so-called ‘leveraged loans’. these are debt obligations typically belonging to borrowers on the lower end of credit ratings but whose higher level of risk offers comparatively more generous returns.

the appeal of leveraged loans and the lower tranches of clos is the double digit returns they offer, which has been particularly magnified in an environment of falling interest rates. the negative-yielding bond market almost topped $17 trillion in 2019. at the end of that same year, 51 percent of all new investment grade bonds were rated bbb. put another way, a majority of comparatively safer debt issues wereright on the cusp of being designated “noninvestment grade” or “junk”.

the precarious nature of this debt is now being tested by the coronavirus outbreak that is threatening to plunge the world economy and financial markets into the worst turmoil since the great depression. “the great lockdown” – to quote imf chief economist gita gopinath – has put a myriad of businesses at risk of closing their doors, and imperiled firms – particularly non-financial corporations – with high borrowing costs.

the new economic circumstances have consequently brought forth the much-feared prospect of a wave of credit downgrades, specifically in the corporate debt sector and clos into which these obligations have been securitized. the total share of b- rated loans in the leveraged loan market is at a record high following 114 downgrades by s&p global ratings in march alone.



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