Stimulus Devotees Giving Edge to Euro Corporates: Credit Markets
Yields on euro-denominated corporate bonds have fallen below those in dollars by the most in more than four years, as debt investors seek assets in a region where central bankers are showing few signs of paring stimulus measures.
Yields on investment-grade euro debt fell to as much as 1.4 percentage points less than those on dollar-denominated debt last month, compared with 0.8 percentage points below the U.S. bonds at the end of 2012, according to Bank of America Merrill Lynch index data. The gap, which was 1.25 percentage points less yesterday, has averaged 0.8 during the past 10 years.
While the Federal Reserve is considering a reduction of bond purchases that have bolstered credit markets, European Central Bank President Mario Draghi has described progress in the region as “tentative” and pledged to keep interest rates at their lowest-ever levels for an “extended period.” Europe is estimated by economists to have ended its longest recession since the single-currency union started 14 years ago.
“The ECB remains quite accommodative, and is increasing their policy accommodations, just as the Fed is most likely reducing theirs,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. “I think we’re still a good year away from the ECB reaching their potential turning point.”
Bonds issued by Banco Bilbao Vizcaya Argentaria SA (BBVA) and Telefonica SA (TEF) are leading gains of 1.06 percent this year for high-grade, euro-denominated debt, compared with a 3.2 percent loss for similarly rated securities in the U.S., according to Bank of America Merrill Lynch index data. JPMorgan Chase & Co. strategists led by Jan Loeys are recommending investors buy euro debt, predicting the rally will continue even after yields on the debt fell below dollar securities last month by the most since 2008, before the region’s fiscal crisis erupted.
Euro corporate bonds have gained 14.2 percent since the end of 2011 after the ECB cut interest rates to the lowest ever in an effort to end six consecutive quarters of economic contraction.
Investment-grade bonds in the U.S. returned 55.6 percent in the four years after 2008 as the Fed unleashed an unprecedented bond-buying program to ignite growth following the nation’s worst recession since the Great Depression. Their losses this year come as the central bank debates slowing the debt purchases in the face of declining jobless rates and accelerating growth.
“In Europe, easy monetary policies are not likely to be reversed or slowed in the near term,” Edward Marrinan, a macro credit strategist at Royal Bank of Scotland Group Plc’s securities unit in Stamford, Connecticut, said in a telephone interview. “The underperformance of the U.S. market has nothing to do with underlying credit fundamentals and has everything to do with interest rates.”
Elsewhere in credit markets, Burlington Northern Santa Fe LLC raised $1.5 billion in its first bond offering in five months. Two Harbors Investment Corp. (TWO) is planning its first issuance of home-loan securities without government backing. Marathon Asset Management LP, one of nine firms selected to manage a government-subsidized program to revive the mortgage-bond market, liquidated the fund after handing the U.S. Treasury a 25 percent return.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 0.5 basis point to a mid-price of 75.3 basis points, according to prices compiled by Bloomberg.
The Markit iTraxx Europe Index of credit-default swaps tied to the debt of 125 companies with investment-grade ratings increased 0.8 to 95.5 at 10:38 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan fell 1.6 to 134.2.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit 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, rose 0.6 basis point to 18 basis points. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Charlotte, North Carolina-based Bank of America Corp. were the most actively traded dollar-denominated corporate securities by dealers yesterday, accounting for 3.7 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Burlington Northern, the railroad that Warren Buffett’s Berkshire Hathaway Inc. bought in 2010, sold $800 million of 3.85 percent, 10-year notes that yield 117 basis points more than similar-maturity Treasuries and $700 million of 5.15 percent, 30-year securities at 140 basis points more than benchmarks, according to data compiled by Bloomberg.
Proceeds from the sale will be used for general corporate purposes, which may include capital expenditures and debt repayment, the Fort Worth, Texas-based company said in a regulatory filing yesterday.
Two Harbors, the mortgage real-estate investment trust run by Pine River Capital Management LP, plans to issue debt including $400.7 million of top-rated bonds tied to a “high-quality mortgage pool,” Fitch Ratings said yesterday in statement.
After buying the junior-ranked portion of a Credit Suisse Group AG deal in the first quarter, the Minnetonka, Minnesota-based REIT accumulated $520 million of prime jumbo mortgages it could securitize itself when market conditions allowed, Chief Investment Officer William Roth said an Aug. 7 conference call.
Marathon sold the last of its fund’s $1.5 billion of residential and commercial mortgage-backed securities holdings in June, the New York-based firm said in a letter dated Aug. 12. Of the managers chosen for the government’s Public-Private Investment Program, Marathon had the highest return on capital with a net multiple of 1.76 times.
PPIP was started in March 2009 to encourage purchases of devalued real-estate loans and mortgage bonds that helped cause the financial crisis and weighed on banks’ balance sheets. Originally envisioned to soak up as much as $1 trillion in assets, the Treasury invested $18.6 billion in debt and equity. That included $475 million in equity in Marathon’s fund, in which private investors also put $475 million, according to an Aug. 1 quarterly program update on the Treasury’s website.
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index fell for a second day, decreasing 0.01 cent to 98.06 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 3.19 percent this year.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
In emerging markets, relative yields narrowed 6.2 basis points to 334 basis points, or 3.34 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 301.4 basis points this year.
Investment-grade bond returns in Europe are outpacing their U.S. peers for the fourth straight month, the longest stretch since the period ended March 2012, Bank of America Merrill Lynch index data show.
Investors demanded an extra 135 basis points to own euro-denominated corporate bonds instead of government securities yesterday, Bank of America Merrill Lynch index data show. That was 17 basis points less than the 152 basis-point yield spread on dollar securities, the data show. The gap between debt in the two currencies averaged 48 basis points from 2005 to 2007.
The difference between relative yields in the two regions is a reversal from 2011, when spreads on euro bonds averaged 24 basis points more than those on dollar notes as European policy makers negotiated an accord with Greece’s creditors to avoid a default that threatened to unravel the euro zone.
Euro-bond yields averaged 2.15 percent yesterday, compared with 3.41 for dollar debt, the index data show. The 1.4 percentage-point yield gap on July 5 was the biggest since Dec. 8, 2008.
“People are not yet bullish on Europe, and may not become bullish, but the first phase of any outperformance is always reduced pessimism and short-covering,” JPMorgan’s Loeys said in a telephone interview. “You have to play at the margins.”
Yields have since fallen to 2.09 percent in Europe and 3.33 percent in the U.S.
“There’s a likely outperformance for a number of months; it could be even a year,” Loeys said. “Nobody expects Europe to be locomotive that will drive world growth. But simply the lack of a negative, the lack of fiscal tightening and reduced austerity can have a powerful short-term impact.”
The euro-area economy probably edged back to growth last quarter, with gross domestic product expanding 0.2 percent after shrinking for the previous six quarters, according to the median of 41 economist forecasts in a Bloomberg News survey.
“It’s been a painful process but these countries are making progress with respect to financial balance,” Ashish Shah, the head of global credit at AllianceBernstein Holding LP, which manages $435 billion in assets, said in a telephone interview.
Telefonica, Europe’s most indebted telecommunications company, reported smaller-than-anticipated declines in sales and operating profit last month as it cut its net debt to less than 50 billion euros ($66.3 billion).
Its $24.2 billion of bonds included in the Bank of America Merrill Lynch Euro Corporate index have gained 3.09 percent this year. The $13 billion of Spanish lender BBVA’s debt in Europe is up 5.34 percent during the period.
Fed Chairman Ben. S. Bernanke spurred the worst selloff since 2008 for dollar-denominated corporate bonds when he told Congress on May 22 that the central bank may cut the pace of bond purchases at its next few meetings if the labor market shows sustainable improvement.
Bernanke sent Treasury yields to the highest level in almost two years after outlining a plan June 19 in which the Fed could start curtailing the current pace in $85 billion of bond purchases later this year and end them around mid-2014 if growth is in line with the central bank’s estimates.
“This has been a multi-year rally for U.S. corporates and Europe has been slower to follow that lead” due to economic and political turmoil in the region, RBS’s Marrinan said. “With some signs that those pressures are abating, the euro-area corporate credit market has gained performance momentum and has jumped ahead of the U.S.”