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Morgan Stanley: Junk Bonds to Rally for Third Year in 2011

Wednesday, 08 Dec 2010 02:31 PM

Junk bonds may gain for a third year in 2011 even if inflation accelerates, according to Morgan Stanley.

High-yield debt may return 6 percent next year, assuming that interest rates on risk-free assets rise three-quarters of a percentage point, wrote Adam Richmond, a Morgan Stanley researcher, in a report today. If rates remain the same, the New York bank sees speculative-grade bonds earning 9.5 percent.

Morgan Stanley, the sixth-largest U.S. bank by assets, said the debt will perform well as the economy grows modestly, default rates remain low and companies continue to deleverage. High-yield bonds have returned 14.2 percent this year, after advancing 57.5 percent in 2009, according to data compiled by Bank of America Merrill Lynch.

Within high-yield, the “lower-rated buckets” will do the best, Richmond said in a telephone interview.

The potential upside for junk debt is limited by already- low yields and an expected rise in rates on U.S. Treasuries, according to the report. For investors who prefer a more defensive position, Morgan Stanley recommends loans instead of BB rated bonds, Richmond said.

Leveraged loans are protected from accelerating interest rates because they are made at floating rates. Morgan Stanley forecasts they will gain as much as 7 percent next year, according to the report.

High-yield, high-risk debt, known as junk, is rated below Baa3 by Moody’s Investors Service and less than BBB- by Standard & Poor’s.

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Junk bonds may gain for a third year in 2011 even if inflation accelerates, according to Morgan Stanley.High-yield debt may return 6 percent next year, assuming that interest rates on risk-free assets rise three-quarters of a percentage point, wrote Adam Richmond, a Morgan...
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