Corporate-Bond Overload: July’s Sales Deluge Leads to Buyer Fatigue

Why Top-Rated Corporate Bonds Perform Poorly

Bond buyers are getting exhausted after absorbing trillions of dollars of corporate debt in the past few years.

While they still gobbled up a record-breaking $135 billion of U.S. investment-grade bond sales in July, they’re getting pickier. They’re now demanding the most extra yield to own the debt instead of government securities in two years.

“The high-grade bond market feels satiated with paper,” Bank of America Corp. analysts led by Hans Mikkelsen wrote in an Aug. 3 report. “What this market needs is a break -– either in the form of a slowdown in supply volumes or some healthy inflows.”

Dollar-denominated investment-grade bonds have been steadily losing value. Prices on the notes have fallen to an average 104.8 cents on the dollar from 110.4 cents in January, according to Bank of America Merrill Lynch index data.

In 2015, top-rated corporate bonds are up a measly 0.1 percent, underperforming a 0.8 percent return for U.S. government and agency debt. It’s the corporate market’s smallest gain in the period since 2013, when former Federal Reserve Chairman Ben S. Bernanke sent markets reeling by talking about ending the central bank’s bond purchases.

Issuance Surprise

While there is some concern about the Fed’s plan to raise interest rates for the first time since 2006, that isn’t the main reason behind the meager returns.

Instead, you can blame plunging commodity prices, which chilled demand for debt of metals, mining and oil companies. And you can point a finger at the massive amount of U.S. corporate-bond sales last month, about 40 percent of which was unexpected, Citigroup Inc. analysts Sonam Pokwal and Jason Shoup wrote in an Aug. 4 report.

It was “the heaviest July we have on record,” at more than double last year’s showing in the period, they wrote. “Last month’s issuance represents a huge surprise.”

Why do companies still need to borrow so much after selling $7 trillion of U.S. securities since 2008 as the Fed held benchmark rates near zero?

They want to acquire other companies, and they want to pay for it with debt. Almost $40 billion of investment-grade bond sales in July went toward mergers and acquisition activities, Bank of America data show.

Of course, investors bought all of this debt and they’re still willing to put money into this market for the extra yield it offers over alternatives. They’ve poured almost $47 billion into U.S. investment-grade bond mutual funds this year, according to Wells Fargo & Co. data.

At the same time, yield premiums on the debt have climbed to 1.58 percentage point more than benchmark rates, from 1.29 points in March. Amid the July deluge, investors sent spreads up an extra 0.12 percentage point.

It turns out there are some limits to their appetite.

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