Investors are being told to brace for losses in the trillion-dollar junk bond market, with the recent souring in market prices implying that as many as one in ten companies could default.

Distress in the market for junk bonds - also known as high-yield or speculative-grade bonds - is at its highest for five years, according to Standard & Poor's, the credit rating agency.

Bond prices have fallen on fears that growing numbers of issuers will default because of the slowing US economy and the general liquidity shortage. Spreads - the amount that junk bonds yield in excess of risk-free government bonds - ballooned this week to an average of 8 per cent, compared with 6.77 per cent six weeks earlier and 5.61 per cent at the start of the year.

Junk bond spreads implied that one in ten of junk bond issuers would eventually default - a much higher level of pain than most bond industry analysts were forecasting, S&P said. Its estimate is that default rates will soar from 1.2 per cent to between 3.4 per cent and 5.7 per cent in 12 months.

Diana Vazza, S&P managing director, said: “With lending standards tightening and economic activity waning considerably, the likelihood has intensified that mis-steps among low-rated corporates could increase the number of defaults.”

Nearly half of all US bond issuers are now classified as junk because of the trend, until the credit crunch hit, to lift leverage and because of investors' growing appetite for higher yields. S&P tracks 1,200 US junk bond issuers.

Many of America's best-known companies are classified as junk, and S&P regards many of them as liable to downgrade. They include Avis Budget Group, Warner Music Group, Clear Channel Communications, Eastman Kodak and Chrysler.

Bonds of some blue-chip names are trading at wide discounts. General Motors bonds maturing in 2033 are trading at 71 cents on the dollar, while Ford notes due in 2016 are fetching 76cents on the dollar.

S&P has downgraded 381 companies this year, three times as many as it has upgraded. Five bond issuers have defaulted in that period. Meanwhile, investor appetite for new issues of junk bonds has collapsed. Just nine companies successfully raised money in the first two months of the year.

While most junk bonds are held by pension funds, hedge funds and other institutional investors, some are held by banks, which could add to their troubles if conditions deteriorate.

S&P said that the Federal Reserve's decision this week to provide emergency finance to securities dealers should help to stabilise credit markets. But it would have to “wait and see” whether the accompanying 0.75 per cent cut in the US base rate to 2.25 per cent would be enough to tempt investors back into junk bonds.

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