U.S. bond investors who think the market looks about the same as it did three months ago, before summer vacations started, may want to take a closer look.
It’s true that yields on investment-grade bonds are just 0.01 percentage point higher today than at the end of May, and only 0.06 percentage point more on U.S. Treasuries. Yet the mood has changed, with debt buyers growing more pessimistic about the prospects for growth globally and the potential for a misstep in a market addicted to central-bank stimulus.
They’re plowing into bonds that do best when the economy slows, such as Treasuries, investment-grade and long-dated securities. They’ve grown a bit more skittish about riskier speculative-grade debt in the face of escalating conflicts in Ukraine and the Middle East.
“The virtuous cycle supporting credit markets is poised to continue into September as easy monetary policy and geopolitical risks around the globe keep a lid on yields,” Wells Fargo & Co. credit strategists led by George Bory wrote in a report today. “However, easy money also presents a downside.”
A sixth year of near-zero interest rates from the Federal Reserve has companies borrowing at a faster pace than they’ve been increasing their earnings, the analysts wrote.
In Europe, the central bank is fighting deflation with plans to buy bonds, causing yields in the region to plunge to record lows and benefiting U.S. debt by making it look relatively attractive. A surprise from the European Central Bank may spark a sell-off, according to Wells Fargo.
What’s odd about U.S. bond traders’ negativity is that things are looking up for the nation’s economy. Manufacturing expanded in August at the fastest pace in three years as orders grew by the most in a decade. Consumer confidence also unexpectedly increased last month.
So what can explain such a bearish mood?
There’s a sense that if growth hasn’t taken off already after trillions of dollars of stimulus, it may fail to do so over the long term. The U.S. will expand at a 2 percent rate this year, down from 2.2 percent in 2013, according to analysts surveyed by Bloomberg.
“A growing amount of spending, specifically in the U.S. corporate sector, is being financed with debt,” the Wells Fargo analysts wrote.
That’s not the sort of thing that bolsters confidence in the credit-worthiness of the lowest-rated companies. Junk bonds posted their first loss in almost a year in July, declining 1.3 percent even as higher-rated notes gained value, Bank of America Merrill Lynch index data show.
While the notes went on to gain 1.5 percent in August, speculative-grade companies practically stopped selling bonds, with a mere $3.5 billion of the dollar-denominated debt issued last month, Bloomberg data show.
Traders turned bullish on 10-year U.S. Treasury futures for the first time in a year in the week ended Aug. 26 -- typically a vote against stronger growth -- according to U.S. Commodity Futures Trading Commission data.
So, while your screens may show a bond market that looks pretty steady, there’s an undercurrent of change here as those sun tans start to fade.