The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt.

Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserveheld borrowing costs near zero, according to Deutsche Bank AG. Withoil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to eight percent next year.

“Anything that becomes a mania -- it ends badly,” said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management. “And this is a mania.”

The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s Investors Service this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.

Borrowing costs for energy companies have skyrocketed in the past six months as West Texas Intermediate crude, the U.S. benchmark, has dropped 44 percent to $60.46 a barrel since reaching this year’s peak of $107.26 in June.

David Fuller's view

What are the implications of this situation?

Too many people, not least US residents, have assumed that their better economic performance among most developed country markets and the rising Dollar made Wall Street’s markets virtually bullet proof in a globally slow GDP growth environment.  

The US has done well but we are now seeing its temporary vulnerability in a largely unexpected area up until a couple of months ago – the fracking boom which is now under growing pressure from falling energy prices.  As I write this comment WTI crude is currently at $59.16 in after hours trading, following a low at $58.85. 

Keep an eye on the rising VIX Index which now suggests further market turbulence.