Uncertainty about the Federal Reserve Board's next rate move is keeping investors out of the junk bond market, according to Martin Fridson, Merrill Lynch & Co.'s chief high-yield strategist.
Money has flowed out of mutual funds that invest in high-yield bonds for three consecutive weeks, and new issuance has slowed to a trickle.
Some market analysts have grumbled that the outflow of capital has left too many potential deals waiting in the wings.
But Mr. Fridson says the idea of an oversupply drowning the junk bond market is a myth. "Deals are canceled if the market goes against them. The large part of financing is opportunistic," he said.
The Federal Open Market Committee is not scheduled to meet again until the end of June, though it is possible for it to raise or lower interest rates between official meeting dates.
At its last meeting, in mid-May, the committee left rates alone but signaled a bias toward tightening credit.
Bond prices move in the opposite direction from interest rates. Prices of existing fixed-income instruments usually drop in the short term after a rate hike.
But most high-yield analysts say junk bonds may outperform other sectors of the fixed-income markets, as they did after the Fed raised rates in 1994.
Junk bond returns dropped 2.2% that year, compared with a 3.3% decline for corporate bonds overall, according to Sam DeRosa-Farag, Donaldson, Lufkin & Jenrette's director of global portfolio strategy.
A rate hike could conceivably boost issuance as investors are drawn back into the junk bond market by richer yields. But junk bonds are a spread product, meaning investors usually buy them because of their rates relative to those on other financial instruments-not absolute rates.
In the interim, Mr. Fridson advised investors to "buy more high-yield if they think thre will be a bear market in bonds, rather than upgrading quality."
But bond investors show little sign of taking his cue, continuing a flight to quality that began last fall in the wake of Russia's economic crisis.
Ever since, it has been tough for less liquid junk bonds to come to market. That trend only worsened in May, some market watchers said.
Investors are demanding rich yields for smaller issues, which has caused many companies to pull their deals from the market.
The calendar of expected offerings is about half what it was just a couple of months ago, and estimates of the coming volume now range from $4 billion to $5 billion.
Steven Ruggiero, Chase Securities Inc.'s head of high-yield research, said he expects prospective volume to balloon to about $10 billion in June.
Issuers have realized $12.8 billion of proceeds from 58 junk bond offerings this month, through May 26, down from $16.4 billion from 85 issues in the same period last year, according to Thomson Financial Securities Data.
New offerings dwindled to $1.5 billion last week. A large issue for NextLink on Wednesday bumped this week's issuance to about $2 billion, according to Securities Data.
NextLink Communications Inc. of Bellevue, Wash., priced two bonds netting the company $854.4 million in a deal led by Salomon Smith Barney, a Citigroup unit.
The company sold $675 million of 10-year senior notes at par, priced 527 basis points over comparable Treasuries.
But it sold a second tranche at well below par, accepting 55.185 cents on the dollar for a $325 million, 10-year zero coupon bond. That sliced NextLink's proceeds on this tranche to $179.4 million.
Some in the marketplace said this deal drove down the price of the company's existing junk bonds. Typically, a company will pay a premium on new issues to entice investors.
Merrill estimated this week's average junk bond spread over comparable Treasuries at five percentage points, up from 4.69 points two weeks ago, a fairly significant increase. The bad news for issuers seems to cross all major industry sectors, analysts said.
"It's really on a case-by-case basis in terms of what new issues get done and what gets done well," Mr. Ruggiero said.
Volatility in equity markets, such as that in recent weeks, also tends to spook junk bond investors. "That has driven some of the hot money out of the market," Mr. Ruggiero said.
All of these factors have contributed to a roller coaster ride for issuers in this market in recent weeks.
Weekly issuance ranged from as little as $1.5 billion to as much as $7.7 billion this month.