Bond Danger Reaches Record High as Yields Lure: Credit Markets
Corporate bonds have never been more perilous for investors who are scooping up longer-maturity debt at the fastest pace since 2008 in a bet the Federal Reserve will keep interest rates at record lows through late 2014.
The duration of global company bonds, a measure of the securities’ price sensitivity to yield changes that rises with longer maturities, reached a record high yesterday, according to Bank of America Merrill Lynch index data. An investor holding $10 million of United Technologies Corp. (UTX)’s 4.5 percent debentures due 2042 would lose about $565,000 if the yield increased to 4 percent from 3.7 percent now.
While the Fed has said its benchmark rate will likely remain in a range of zero to 0.25 percent through late 2014, Goldman Sachs Group Inc. and Bank of America Corp. say the central bank won’t move until the middle of 2015 as the economy slows. The International Monetary Fund will cut its 3.5 percent estimate for global growth this year, Managing Director Christine Lagarde said last week.
Bond buyers are “reading the tea leaves from the Federal Reserve to mean that there’s no near-term danger of policy rates rising,” Martin Fridson, global credit strategist at BNP Paribas Investment Partners, said in a telephone interview from New York. “As the pressure mounts to get yield, investors one way or another come up with a way to go out longer than they traditionally have.”
The prices of longer-maturity bonds are more sensitive to changes in the current market yields than shorter-dated debt. An equal rise in borrowing costs cuts more value from longer-dated notes that pay a larger number of coupons.
Average yields on investment-grade corporate bonds reached a record-low 3.15 percent yesterday on the Bank of America Merrill Lynch Global Broad Market Corporate index. That’s helping push modified duration, which gauges the price change of a security for a given shift in yield, to an unprecedented 5.84 years as of yesterday, compared with 5.59 years at year-end and last year’s low of 5.28 on March 30.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. climbed for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, rising 1.7 basis points to a mid-price of 113.2 basis points as of 11:44 a.m. in New York, according to prices compiled by Bloomberg.
The measure typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, decreased 1.9 basis points to 21.8 basis points as of 11:45 a.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Bonds of Anheuser-Busch InBev NV (ABI) are the most actively traded dollar-denominated corporate securities by dealers today, with 204 trades of $1 million or more as of 11:46 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The maker of Budweiser and Stella Artois sold $7.5 billion of bonds yesterday in the second-biggest offering of the year.
Borrowers from Kraft Foods Inc. (KFT) to St. Louis-based Monsanto Co. (MON) have responded to record-low borrowing costs by selling $279 billion of dollar debt due in 10 or more years since year-end, the most for a January-through-July period since 2008, Bloomberg data show. Longer-dated new issues account for 48.7 percent of total issuance, up from 42 percent in all of 2011 and the most in three years.
The Fed won’t raise borrowing costs through next year, according to the median estimate of a July survey conducted by Bloomberg. Goldman Sachs and Bank of America both say a weaker- than-forecast June jobs gain will lead the central bank to keep its rate at a record low, where it’s been since December 2008, until the middle of 2015.
“We could be sitting in this type of range-bound interest rate environment” until 2015, Rajeev Sharma, who helps oversee $1.5 billion of high-grade debt at First Investors Management Co. in New York. For higher-quality credits, “investors start to feel, ‘Let me take the longer-end risk and get some yield for it,’ because in the 10-year space or even shorter, it’s just not going to be enough yield to make it exciting.”
Average effective maturities and durations among mutual funds tracked by Chicago-based Morningstar Inc. both increased in May from the previous month and are higher than in January. Maturities on debt held by taxable bond funds increased to 6.52 years from 6.46 years in April and 6.36 at the start of 2012. Duration rose to 4.17 years in May from 4.05 in January.
Two Fed participants said at the central bank’s June meeting that additional bond purchases are appropriate and two others said they would be warranted in the absence of “satisfactory progress” in cutting unemployment or if downside risks increase, according to minutes of the session.
Fed members also said strains in global markets stemming from Europe’s debt crisis had increased since their April meeting, and that “U.S. fiscal policy would be more contractionary than anticipated.”
The Fed under Chairman Ben S. Bernanke bought $2.3 trillion of Treasury and mortgage-related debt to stimulate the economy. It decided in June to extend a policy known as Operation Twist where it sells short-term securities and uses the proceeds to buy longer-term debt to $667 billion from $400 billion.
The “key emerging markets” of Brazil, China and India are showing signs of slowdown and the IMF’s growth outlook “has regrettably become more worrisome,” Lagarde said July 6 in Tokyo. The IMF managing director is pressing for fiscal union in Europe to aid growth and financial stability as nations such as Greece confront a sovereign-debt crisis.
United Technologies raised $9.8 billion in the largest U.S. corporate bond sale in more than three years on May 24 to help finance its $16.5 billion acquisition of Goodrich Corp. Its $3.5 billion portion of 30-year bonds traded at 114.9 cents on the dollar to yield 3.67 percent yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Monsanto, the world’s biggest seed company, sold $250 million of 30-year debt at a record low 3.6 percent coupon July 9. 3M Co., the maker of Scotch tape and Post-It Notes, sold $600 million of 10-year notes with a 1.95 percent coupon on June 21, the lowest coupon ever among similar maturities.
Kraft, the world’s second-largest food company after Nestle SA, sold $6 billion of debt at its record-low coupons May 30 in connection with the planned spinoff of its North American grocery business. The offering included equal $2 billion portions of 10- and 30-year debt that have both increased in price.
“The longer duration is probably being driven by CFOs and treasurers who see record low risk-free rates and say, ‘Why not lock in inexpensive, long-term funding?’” Jim Hannan, a senior money manager in Baltimore at Wilmington Trust Investment Advisors Inc., which oversees about $25 billion in fixed-income assets and is overweight corporate securities, said in a telephone interview.
“The demand is there because of the historically low risk- free rates, and that investors are to a certain degree clamoring for yield and are willing to take on credit risk,” he said.
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