Bernanke’s Cash Fueling Record Corporate Rally: Credit Markets
Federal Reserve Chairman Ben S. Bernanke is fueling a record-long winning streak in corporate debt as the money he pumps into the economy spurs investors to seek riskier assets to generate returns.
Bonds sold by companies around the world, from the neediest to the most creditworthy, are on pace to generate 11 straight months of positive returns, bringing gains over the period to 12.9 percent through Oct. 26, according to Bank of America Merrill Lynch index data. Investor demand has narrowed the yield premium over benchmark government securities to 225 basis points, or 2.25 percentage points, from 356 on Nov. 30, 2011.
After four years of holding its main interest rate at about zero, Bernanke said in September he expects no change in policy through mid-2015 to complement $40 billion of monthly mortgage- bond purchases in an effort to boost growth. With central banks across the world using similar strategies, investors have turned to corporate debt, whose default rates are running below historical averages, as alternatives to government securities.
“The actions by the Federal Reserve have left no choice,” said Scott Colyer, the chief executive officer of Advisors Asset Management Inc., which oversees about $9.5 billion in Monument, Colorado. “If they keep the pedal down” we may “have another year next year that rivals this one in corporate debt,” he said.
Corporate debt has strengthened even as the International Monetary Fund lowered its global growth forecast to the slowest pace since the 2009 recession. Concern that Europe will cause an international financial contagion is mounting as Spain’s economy contracts for a fifth quarter and Greece struggles to obtain international aid.
That scenario, combined with record-low yields, may diminish prospects for further gains.
“You’ve seen a goldilocks environment for credit issuers, but for investors the outlook is less favorable,” said Sam Diedrich, a money manager at Pacific Alternative Asset Management Co., which oversees $8.5 billion. “We’ve been in a market that’s very conducive to credit because you have low interest rates, low default rates, and high investor demand for yield. However going forward, we see value in other areas outside” high-yield markets, such as structured products, he said.
Telefonica Emisiones SAU, a financing unit of Spain’s biggest phone-services company, led returns of 3.51 percent this month on Bank of America Merrill Lynch’s Global Broad Market Corporate & High Yield Index. The company’s bonds were followed by Italian rival Telecom Italia SpA (TIT), which gained 2.79 percent. Overall, returns total 0.9 percent this month, the same as in September.
Elsewhere in credit markets, trading of fixed-income securities in the U.S. is closed today after the Atlantic superstorm Sandy paralyzed Wall Street. A gauge of credit risk tied to junk-rated companies in Europe fell for the first time in almost two weeks. Fresenius Medical Care AG, the world’s biggest provider of kidney dialysis, is said to be signing about $3.85 billion in loans today to refinance its outstanding debt.
The Markit iTraxx Crossover Index, a credit-default swaps benchmark that investors use to speculate on the creditworthiness of 50 mostly junk-rated European companies, dropped 18.1 basis points to 526.5 basis points at 3:41 p.m. in London. The decline snapped eight days of increases.
Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. The contracts 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 swap protecting $10 million of debt.
Fresenius’s five-year deal comprises a $2.6 billion term loan A and a revolving credit facility of about $1.25 billion, according to two people with knowledge of the situation, who asked not to be identified because the transaction is private. The Bad Homburg, Germany-based company canceled a planned term loan B because of demand for the term loan A, which was increased from $1.8 billion, the people said.
Term loan A facilities are sold mainly to banks while B and C portions are usually taken by non-bank investors such as collateralized loan obligations, bank loan mutual funds and hedge funds.
Europe leads gains in corporate bonds this year, as policy makers’ efforts to ease the sovereign crisis lured investors seeking alternatives to benchmark government securities with often negative yields.
European corporate debt returned 14.8 percent, compared with 0.6 percent in the same period of 2011, according to Bank of America Merrill Index data. U.S. company notes earned 10.6 percent, up from 5.7 percent, the data show. Globally, returns climbed from the 4 percent achieved in the year to Oct. 26, 2011.
Global sales totaled $3.3 trillion year-to-date, up from $2.8 trillion in the same period of 2011, according to data compiled by Bloomberg.
The amount investors earn from corporate debt will decline in 2013 because of the effect of western governments’ spending cuts on economic growth, according to analysts at Societe Generale SA and National Australia Bank Ltd.
The IMF is predicting the world economy will grow 3.3 percent this year and 3.6 percent next year, it said on Oct. 9. That compares with July predictions of 3.5 percent in 2012 and 3.9 percent in 2013. The Washington-based lender now sees “alarmingly high” risks of a steeper slowdown, with a one-in- six chance of growth slipping below 2 percent.
“Returns this year have been superb, however we can’t expect these to be replicated in 2013,” said Simon Ballard, senior credit strategist at NAB in London. “Given the on-going macroeconomic challenges from austerity, we would anticipate a drop in returns for investment-grade issuance from current levels back toward the low- to mid-single digits next year, and on high yield, back to the high-single digits area at best.”
Growth in U.S. gross domestic product will slow to 2 percent next year, from 2.1 percent in 2012, according to the median estimate of 89 economists surveyed by Bloomberg. Governments across Europe are also implementing austerity as an economic policy to cut unsustainable debt levels and meet requirements for staying in the euro.
“Our forecast for 2013 is not ready yet, but we expect returns to be substantially lower -- 3 percent would be a good starting point,” said Suki Mann, SocGen’s London-based head of credit strategy. He maintained his forecast of 12 percent returns for this year.
Corporate bonds appeal because of their relative yield and safety. The global speculative-grade default rate of 3 percent as of the end of the third quarter was lower than the 4.8 percent historical average since 1983, according to an Oct. 8 report by Moody’s Investors Service. That’s still almost double the 1.8 percent rate of a year ago as the euro-region crisis in particular hurts company earnings.
“The corporate default rate has remained low and stable for some time now, despite some very weak economic fundamentals,” Albert Metz, a Moody’s analyst, wrote in the report. “With ample liquidity available, we are not expecting that to change over the coming months.”
The European Central Bank cut its main refinancing rate a quarter-percentage point to a record-low 0.75 percent in July, after starting to reduce it at the end of 2008. This pushed yields on the safest European government bonds including Germany’s and Austria’s, below zero. Only after ECB President Mario Draghi reassured markets by announcing an unlimited bond- buying program on Sept. 6 did they start rising again.
The yield on Germany’s two-year note dropped to an all-time low of minus 0.097 percent on Aug. 2, and was 0.04 percent today, while the Netherlands’ similar-maturity bond fell to minus 0.035 percent on the same day, before recovering to 0.084 percent. U.S. two-year Treasury rates declined to 0.143 percent in September 2011 and hovered above 0.2 percent for much of this year, reaching 0.285 percent yesterday.
“Demand for credit is still strong,” said NAB’s Ballard. “There’s still a lot of cash out there looking to get invested and seeking yield.”