NEW YORK, July 3 (Reuters) - Risks in high-yield or "junk" bonds are growing as the already flagging U.S. economy shows more signs of slowing drastically, according to Diane Vazza, head of global fixed-income research at Standard and Poor's Ratings.

Junk bonds provide higher income than investment-grade bonds to compensate investors for their higher risk of default. However, Vazza said in a research report there are 10 headwinds for the market, including rising defaults, a deterioration in credit quality and reduced ranks of junk-bond investors, especially in the hedge-fund arena.

The 10 concerns she highlighted are:

- A deteriorating economy, weaker earnings prospects andlending constraints will push defaults higher, Vazza said. Default rates should continue to climb throughout the year, with the 12-month-trailing speculative-grade default rate hitting 4.7 percent by the first quarter of 2009, she said.

- As default pressures mount, more firms may exercise payment-in-kind (PIK) features, paying bondholders with additional securities instead of coupons. "Another sign of stress is the increase in the number of borrowers seeking covenant relief," she said. "However, the increased use of PIK-toggle notes and covenant-lite loans in the past two years could help mitigate the increase in defaults in 2008, by either providing time for firms or the economy in general to rebound or by extending the default timing into 2009."

- Balance sheet repair by banks and brokers will limit new issuance. "Lending standards have tightened, and underwriters have lowered their risk-tolerance levels," Vazza said. High-yield issuance in the first half of 2008 totaled $30 billion, the lowest since the dismal $24 billion in the first half of 2000, she noted.

- Risky, highly leveraged firms will continue to find it challenging to access the high-yield bond market, she said. In 2007, 51 percent of new issuance in the high-yield market was rated 'single-B-minus' or below, with 26.3 percent rated 'triple-C-plus' or below. In the first half of 2008, only 15.5 percent of new supply was rated 'single-B-minus' or below, and much of this was tied to delayed deals from 2007.

- High-yield spreads will likely remain in the previous two months' trading range of 640-700 basis points over Treasuries, but with a higher risk of extended widening, given the uncertainty about the economic and financial market prospects and expectations of rising defaults in the next four quarters.

- Markets should remain volatile as economic uncertainty continues.