Last checked at 
By Danielle Robinson and Joy Ferguson
NEW YORK, May 17 (IFR) - If anyone needed evidence thatparts of the high-yield bond market no longer offer protectionagainst rising interest rates, then they received it this week,when the highest quality, longest dated new issues sufferedlosses of as much as two points in dollar price.
Ball Corp's recently issued US$1bn 4.00% par10.5-year notes plunged to a low of 98.75, as investors watchedthe 10-year Treasury rate surge almost 20bp by Wednesday, to1.94% from 1.75% the previous week.
Other Double B names that have recently locked in record-lowsub-5% pricing - like Targa Resources and CommercialMetals - were also languishing under their par new issuelevels.
That level of underperformance by so many high-qualityissuers at once has been rare in the roaring high-yield marketthis year, and some fear it marks a shift in the perception thatall high-yield offers a cushion against rising Treasury yields.
"Rising rates makes us wary of bonds that have had theirspreads compress so much they have become more rate-sensitive,"said Ashish Shah, co-head of global credit investment atAllianceBernstein.
"Interest rate-sensitivity of many bonds has risen asspreads have compressed, making them more exposed to risingrates," said Shah. "Many investors assume that the return in aproduct that has become much higher quality has come from creditimprovement, whereas some of that return has come from the ratescomponent."
CHANGE IN FORTUNE
The sudden change in fortune for Double B 10-year paper wassparked by a US$478m outflow from high-yield ETFs in the weekending May 15, as retail investors and institutional accountsreacted to rumours the Federal Reserve was talking of taperingoff quantitative easing.
Investors are now focusing on Single B and Triple C names,which offer much more spread protection against dollar pricedeclines as Treasury yields rise.
That was borne out last week by healthcare manager Alere (Caa1/CCC+), whose US$425m seven-year non-call threesenior subordinated issue surged to 101.25 bid by mid-week froma 6.5% par pricing on Monday.
Low-rated deals are now being churned out to take advantageof the shift in investor mentality, while Double B high-qualityissuers are being warned of the difficulty of getting 10-yeartranches done.
"It's getting more difficult to do a longer datedhigh-quality deal in the primary market and we're starting tosee a lot more lower Single B and Triple C paper emerge," saidan investor.
Last week, lower quality names like Bon-Ton Stores,Nextel International, Freescale Semiconductor, FirstData Corp and Univision all rushed to market.
Interest rate sensitivity is usually only a concern forinvestment-grade corporate bonds, because Treasury rates make upa larger component of the overall yield than the credit spread.Investment-grade accounts usually hedge out interest rate riskas a result.
Total return investors, however, look for the coupon and thedollar price gains when they invest and therefore remain exposedto the interest rate component of the yield.
High-yield bonds still offer a very large amount of creditspread as a percentage of a bond's total yield.
SHOCK TO INVESTORS
But what frightens retail accounts is today's combination ofhistorically low Treasury rates and historically low Double Byields.
"In mid-2004-2006, Double B spreads were in the 200bp range,but back then 10-year Treasury rates were around 4%," said KyleJennings, head of credit research at Newfleet Asset Management.
"Although Double B spreads are around 300bp today, with a10-year Treasury at 1.91%, there is a lot of room for interestrates to go back up to 4%, and that's what people are fearing."
What is a shock to investors of all types, is how much thepullback in Double B rated long-dated bonds is a reflection ofFed policy comments.
"Market concern about when the Fed will end QE is one of thebiggest factors affecting spreads in the near term," said EricGross, high-yield credit strategist at Barclays.
High-yield credit spreads have historically shown apropensity to tighten when rates rise, and that has been thecase so far: The 10-year Treasury yield started this year around1.7% and is now around 1.9%. During that 20bp back-up, theoption-adjusted spread of Double Bs has tightened about 57bp,from 376bp to 319bp.
This is one reason why some of the savvier investorsconsider the recent back-up in Double B paper a buyingopportunity.
But those investors looking to buy at these levels all thinkthat either the 10-year Treasury yield is rangebound with armedium-term resistance of 2.00%, or that QE worldwide willcontinue to drive ever more money into junk bonds.
The question is whether those opportunistic buyers andyield-hunters will be large enough to keep spreads tightening,or whether persistent interest rate rises spark a stampede bythe retail herd and send spreads wider.
"It's true that you never know where the money is going andwhich has more sway, retail money going out or opportunisticmoney coming in," said one chief investment officer at a largeinstitutional fund management firm.
"I would think, because of the incredible amount of QEworldwide and flows yet to be felt in full from Japan, that anyyield increase and spread-widening would be an opportunity tobuy that's my bet."
For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol:
U.S. corporate bond price quotations...
U.S. credit default swap column........
U.S. credit default swap news..........
European corporate bond market report..
European corporate bond market report..
Credit default swap guide..............
Fixed income guide......
U.S. swap spreads report...............
U.S. Treasury market report............
U.S. Treasury outlook...
U.S. municipal bond market report......
