Corporate bond trading is soaring to record levels in the U.S. with the biggest buyers churning more of their funds as policy makers consider tapering unprecedented economic stimulus.
Regulatory data show average investment-grade trading rose to $13.9 billion for the busiest May ever, accelerating after Federal Reserve Chairman Ben S. Bernanke said the central bank could slow unprecedented stimulus if the economy shows sustained improvement. Loomis Sayles & Co.’s Dan Fuss said last week he’s shifting into shorter-dated notes in anticipation of rising interest rates.
Investors who had grown reluctant to part with bonds during the biggest four-year rally since 1993 are more willing to trade the notes with the Bank of America Merrill Lynch U.S. Corporate index posting its biggest monthly loss since the height of the credit crisis. With money managers racing to protect their gains as yields climb from a record low 2.65 percent reached on May 2, top-graded notes maturing in less than three years are returning more than longer-dated debt for the first time since 2009.
“You can make money in a bond portfolio,” Fuss, manager of the $23.2 billion Loomis Sayles Bond Fund, said May 30 in an interview at Bloomberg LP headquarters in New York. One way to do it is to “bring in the maturities, ax the market sensitivity,” said Fuss, whose fund has beaten 97 percent of rivals during the last three years.
Investment-grade trading volumes rose 17.8 percent from $11.8 billion in the corresponding month last year and surpassed the previous record of $13.4 billion in May 2009, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
As concern mounts that prices for government debt will fall if the Fed begins to slow its $85 billion of monthly bond purchases, investors are rushing to sell notes that are most-sensitive to moves in Treasury yields.
Investment-grade corporate bonds that mature in seven-to-10 years lost 3 percent in May, the biggest monthly decline since a 9.2 percent loss in October 2008 at the height of the credit crisis, according to Bank of America Merrill Lynch index data. Notes due in one-to-three years declined 0.12 percent.
Pacific Investment Management Co.’s $5.1 billion Total Return Exchange-Traded Fund is reducing its longer-maturity debt, cutting the proportion of notes due in more than 10 years by 13.4 percentage points in the first five months of the year to 32 percent, according to data compiled by Bloomberg. The fund almost quadrupled its allocation of debt maturing in one-to-three years to 20 percent.
“For a while there, we’ve all been on the same side of the trade, with everyone having a pretty constructive view of credit,” said Brian Machan, a Des Moines, Iowa-based money manager at Aviva Investors North America Inc. who helps oversee $433 billion. “There are starting to be different views on the start of the Fed tapering.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 0.3 basis point to a mid-price of 79 basis points as of 11:41 a.m. in New York, according to prices compiled by Bloomberg.
The index 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 debt market stress, increased 0.3 basis point to 16.7 basis points as of 11:41 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.
Bonds of Rio de Janeiro-based Petroleo Brasileiro SA are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.2 percent of the volume of dealer trades of $1 million or more as of 11:38 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Bloomberg Global Investment Grade Corporate Bond index has gained 0.26 percent this month, paring the decline for the year to 1.51 percent.
Returns on investment-grade corporate notes suffered the worst loss in more than four years last month after Bernanke said May 22 that the central bank could reduce its monthly purchases of $45 billion of Treasuries and $40 billion of mortgage bonds “in the next few meetings” on continued economic growth.
The 2.28 percent decline on the Bank of America Merrill Lynch U.S. Corporate index was the biggest since a 7.38 percent loss in October 2008, the month after the bankruptcy of Lehman Brothers Holdings Inc. ignited the worst financial crisis since the Great Depression. Yields have climbed to 3.004 percent as of yesterday.
While notes maturing in one-to-three years returned 0.7 percent this year through May 31, those due in seven-to-10 years declined 0.9 percent, Bank of America Merrill Lynch index data show. That’s the first time the shorter-term notes have outperformed longer-dated debt since the period in 2009.
The average daily volume of dollar-denominated investment-grade bonds traded in January through May rose to $13.4 billion, the most ever for the period, from $12.7 billion during the corresponding five months of 2012, Trace data show.
Trading in the period from May 22 through the end of the month was up 5 percent from the rest of the year.
“People were pretty complacent going into that speech, really expected rates to stay at a really low level,” said Jon Sablowsky, the head of trading at Brownstone Investment Group LLC in New York. “We got some commentary that was unsettling for the market. It was a good catalyst.”
The proportion of investment-grade notes outstanding that traded on average each day from May 22 through the end of the month was 0.34 percent, about equal to the same period last year, Trace and Bank of America Merrill Lynch index data show. That’s a departure from the three full years after 2009, when daily average trading increased by 1.7 percent compared with a market expansion of 40 percent, according to the data.
“People are selling longer-end holdings and investing in shorter and safer paper,” Sablowsky said. There’s “lots of focus on duration for sure.”
Based on options trading, concern that Fed stimulus is poised for a reduction is taking a bigger toll on confidence in bond markets than stocks. Indexes that measure expected volatility in equities are diverging by the most in a year compared with Treasuries, Bloomberg data show.
Bank of America Merrill Lynch’s MOVE Index, which tracks option projections for swings in U.S. government debt, climbed 62 percent to 79.99 in May. That’s three times the monthly increase for the Chicago Board Options Exchange Volatility Index of Standard & Poor’s 500 Index contracts.
The Fed has pumped more than $2.5 trillion into the financial system as part of its effort to rescue the economy from the credit seizure. In the four years ended in December, dollar-denominated investment-grade notes returned 55.6 percent, the most since the 55.7 percent gain in the period ended Dec. 31, 1993.
Fed Bank of San Francisco President John Williams said yesterday policy makers may start reducing the pace of bond purchases over the next three months and potentially end quantitative easing by year-end.
With continued “good signs” on jobs and confidence in a “substantial improvement” I could see as “early as this summer some adjustment, maybe modest adjustment downward, in our purchase program,” he said in Stockholm.
“People are not only shortening duration, they’re also moving up in quality,” said Charles Sanford, a managing director in corporate credit at Babson Capital Management LLC, which oversees more than $180 billion. “Shorter-duration, higher-quality corporate investment-grade securities are almost like the new Treasury right now.”