Aug. 27 (Bloomberg) -- Mario Draghi’s words have lost none of their potency. Just look at the bond market where the European Central Bank president’s hints about further stimulus soothed investors unsettled by turmoil from Ukraine to Iraq.
After Draghi indicated in Jackson Hole, Wyoming, that he’s moving closer to quantitative easing, the average yield investors demand to hold investment-grade bonds in euros fell to a record 1.32 percent, according to Bank of America Merrill Lynch indexes. Junk-bond yields also dropped to 3.79 percent, 34 basis points shy of an all-time low.
While corporate treasurers are benefiting from the record-low borrowing costs, investors in investment-grade bonds earned 6.3 percent this year, with the securities heading for their longest winning streak since 2009. Draghi’s consideration of quantitative easing, which could involve broad-based asset purchases, signals benchmark interest rates are on hold for an extended period as he confronts falling prices and weak growth.
“European credit assets remain buttressed by low default rates, low growth and very low inflation, which is supporting demand for bonds,” said Michael Scott, a London-based credit fund manager at Schroders Plc, which oversees $464 billion of assets. “Future easing will maintain the bid for yield as underlying bond yields fall.”
Investors in corporate debt are benefiting from a rally in government bonds, with investment-grade debt heading for an eighth consecutive month of positive returns. While borrowing costs for countries from Italy to Ireland are at all-time lows, the extra yield investors demand to hold corporate bonds rather than similar-maturity government debt is approaching the lowest in seven years.
Draghi told the Federal Reserve Bank of Kansas City’s annual economic symposium last week that policy makers will use “all the available instruments needed to ensure price stability” and that the central bank is “ready to adjust the policy stance further.”
His comments helped Italy sell zero-coupon two-year notes at a record 0.326 percent yesterday, while German 10-year bund yields remain below 1 percent.
“Draghi’s comments have opened the markets’ eyes to the fact that we’ll continue to see a very dovish ECB,” said Jens Vanbrabant, lead money manager at London-based investment firm ECM Asset Management Ltd., which oversees $8 billion. “Spreads will probably tighten further and new issuance will be lapped up as markets re-open in September.”
Euro-area inflation slowed to 0.3 percent this month, a fraction of the ECB’s goal of just under 2 percent, according to the median forecast in a Bloomberg News survey before an Aug. 29 report. Other releases this week may show unemployment sticking close to a record high and economic confidence falling, according to Bloomberg surveys. Data on Monday showed business confidence in Germany, the region’s biggest economy, slid for a fourth month.
Draghi’s concern is that if inflation expectations keep falling, they’ll affect actual inflation as investors, consumers and companies pull back spending in anticipation of even weaker prices. That could tip Europe into a deflationary spiral that would be hard to reverse.
Companies are making the most of low borrowing costs, raising 577 billion euros ($761 billion) from bond sales this year, a 21 percent increase from the same period in 2013 and the most since 2011, according to data compiled by Bloomberg.
Bayerische Motoren Werke AG sold 1 billion euros of four-year bonds yesterday that pay a coupon of 0.5 percent. That compares with the 1.625 percent the German automaker offered on 5 1/2-year debt it issued in January, Bloomberg data shows.
Issuance has slumped since July, when a selloff in the high-yield debt market was triggered by investor concern that they weren’t being sufficiently rewarded for taking on risk as geopolitical tensions escalated. While August is historically a quiet month, sales of 13.8 billion euros of bonds are the lowest in any month since at least 1999 and compare with 44 billion euros in the same period last year.
European investment-grade corporate bonds yield 98 basis points more than similar-maturity government debt, down from a record 463 basis points in 2009 and near the seven-year low of 97 basis points reached in June, Bank of America Merrill Lynch indexes show.
Investors are right to question if spreads are too tight, said Richard Ford, the London-based head of European fixed income at Morgan Stanley Investment Management, which oversees $396 billion of assets.
“But you don’t want to be the boy who cried wolf by calling a correction too soon,” said Ford.
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