Animal Spirits Revived as Tea Party Delays Taper: Credit Markets
Higher risk assets are back in demand as investors turn their attention to the sudden prospect of Federal Reserve stimulus extending into 2014 after a government shutdown did more to damage the reputations of lawmakers than to fixed-income securities.
Returns for the year on bonds of companies worldwide turned positive this month for the first time since May. Emerging markets are posting their first back-to-back monthly gains of 2013. Yields on 10-year Treasuries, which are a benchmark for everything from corporate debt to mortgages, fell last week to the lowest levels since Aug. 9, keeping alive the three decade bull market in bonds.
“There’s a degree of animal spirits,” Scott MacDonald, head of research a MC Asset Management Holdings LLC, the investment firm majority-owned by Mitsubishi Corp. that oversees $600 million. “It’s been a challenging year in the bond market and here’s your opportunity to play catch up.”
Investors who pulled $123 billion from bond funds in June, July and August on concern the Fed was preparing to scale back its unprecedented stimulus measures are now putting some of that back as a Bloomberg News survey of economists shows the central bank may not reduce its bond purchases until March. Standard & Poor’s estimates the government shutdown shaved at least 0.6 percent from growth in the world’s biggest economy this quarter.
Stocks in the U.S. are trading at records amid the broadest rally in at least a quarter century. The Standard & Poor’s 500 Index jumped to a record on Oct. 18 and the index gained 2.4 percent last week, the most since July. Shares of more than 45 companies in the benchmark gauge have risen this year, the most since at least 1990, data compiled by Bloomberg show.
Corporate bonds from the riskiest to the most creditworthy borrowers worldwide have gained 0.9 percent this year, erasing a loss that reached 2.2 percent in June, Bank of America Merrill Lynch Global Corporate & High Yield Index show. The rebound is poised to spare investors from the first annual loss since 2008.
Average yields fell 0.1 percentage point last week to 3.61 percent, the biggest decline since the week ended Sept. 20, after U.S. lawmakers ended a budget stalemate that partially closed the government for 16 days and raised the nation’s borrowing limit to avert a potential default by the world’s biggest borrower. Yields have dropped from a 14-month high of 3.97 percent on Sept. 5.
The solution is temporary, as lawmakers in Congress voted to fund the government only through Jan. 15, and suspend the debt ceiling through Feb. 7. Tea Party-allied Republicans, such as Texas Senator Ted Cruz, said last week they would keep fighting against President Barack Obama’s 2010 health-care law, which they demanded the government defund.
“It’s kind of a knee-jerk reaction to the fact that the worst-case scenario didn’t play out,” said James Kochan, Wells Fargo Funds Management LLC’s chief fixed-income strategist. “If I had a dollar for every time I lived through a so-called debt-ceiling crisis, I’d retire.”
Americans are expressing frustration with members of Congress, according to a Pew Research Center survey. A record 74 percent of registered voters say most members of Congress shouldn’t be re-elected in 2014, with 18 percent saying they should, according to the poll released Oct. 15. In October 2010, 51 percent said most incumbents shouldn’t be returned to office.
An index of everything from U.S. Treasuries to dollar-denominated corporates on the cusp of junk is up 1.7 percent since the day before the Fed’s Sept. 18 decision to maintain its $85 billion off monthly bond purchases.
That cut the decline for the year on the Bank of America Merrill Lynch U.S. Broad Market Index to 1.5 percent from more than 4 percent last month, when the index was poised for its biggest annual loss in data dating back to 1976.
Yields on benchmark 10-year Treasuries dropped to 2.54 percent on Oct. 18, a 12-week low on an intraday basis, from 3 percent on Sept. 6.
Emerging-market dollar-denominated bonds have returned 2.4 percent this month, following a 2.7 percent gain in September, according to JPMorgan Chase & Co.’s EMBI Global Index. The rally has trimmed losses for the year to 5.18 percent from as much as 11 percent in June. Yields declined to an average 5.77 percent from an almost two-year high of 6.5 percent on Sept. 5.
“We are becoming much more bullish on emerging markets right now,” Bob Maes, a money manager who oversees about 3 billion euros ($4.1 billion) for KBC Asset Management SA, said in a telephone interview from Luxembourg. “The debt ceiling and fiscal issues will further delay Fed tapering. It’s a quite benign environment.”
The gains are emboldening investors to start redeploying cash after the unprecedented $123 billion that TrimTabs Investment Research estimated was withdrawn from bond funds in the three months ended Aug. 28.
Investors funneled $626 million into U.S. high-yield bond funds in the week ended Oct. 16, the most in three weeks, according to data compiled by Royal Bank of Scotland Group Plc. High-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and less than BBB- by S&P.
They poured $635 million into long-term corporate bond funds, the data show. Company debentures maturing in more than 15 years have gained 1.9 percent this month, about 1.7 percentage points more than returns on bonds coming due between one and three years, the biggest outperformance since April, Bank of America Merrill Lynch index data show.
Rock & Roll
The two-biggest exchange-traded funds that focus on junk bonds reported about $759.4 million of deposits in the two days after Oct. 16, when the federal government ended its stalemate over the budget, Bloomberg data show.
Investor demand spurred 7 million of shares created in the $9.8 billion SPDR Barclays High Yield Bond ETF (JNK), the most for a two-day period since November, and 5.1 million of shares in BlackRock Inc.’s $16 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the most for the period since January 2012, the data show.
“The market is positioned from a supply-demand balance where high-yield can rock and roll going into the end of the year,” said Jason Rosiak, the head of portfolio management at Newport Beach, California-based Pacific Asset Management. The Pacific Life Insurance Co. affiliate oversees about $4.3 billion.
The shutdown and debt-ceiling stalemate largely paralyzed issuance of new corporate debt in the U.S. following the biggest month ever in September, led by Verizon Communications Inc.’s record $49 billion bond sale on Sept. 11. Dollar-denominated sales of $59.9 billion this month are down from $212.3 billion in September, Bloomberg data show.
A measure of corporate-credit risk in the U.S. reached the lowest level in almost six years last week.
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 5.5 basis points last week to a mid-price of 71.3 basis points, according to prices compiled by Bloomberg. That’s the least since November 2007 in data that adjust for the effects of the market’s shift to a new version of the index last month. The index traded at 72.1 basis points today at 11:01 a.m. in New York.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose today from the lowest in 3 1/2 years, climbing 1.5 to 86.3.
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.
In the market for speculative-grade loans, the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose from an almost two-month low, climbing 0.07 cent last week to 97.57 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 3.51 percent this year.
State and local bonds rallied compared with their federal counterparts amid the U.S. government shutdown. The ratio of 10-year yields, a gauge of relative value, declined to 102 percent on Oct. 15, the smallest since Sept. 26.
An index measuring the health of U.S. financial conditions reached a record the day Congress arrived at a fiscal deal.
The Bloomberg U.S. Financial Conditions Index, which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, added 0.07 last week to 1.53 and was at 1.54 today. The gauge, which rises as conditions improve, reached 1.55 on Oct. 16, the highest in data dating back to January 1994.
Rates on one-month Treasury bills fell to 0.015 percent on Oct. 18, after surging to a six-year high of 0.45 percent two days earlier. Investors dumped the shortest maturity U.S. government debt on concern principle and interest payments would be delayed or defaulted on if a budget agreement wasn’t reached.
While the jump in bill rates proved to be short lived, the shutdown did cost the U.S. more to borrow. The $35 billion in three-month bills the Treasury sold on Oct. 15 were auctioned at a discount rate of 0.13 percent, the highest since February 2011. That compares with 0.01 percent at the Sept. 30 auction.
The U.S. sold $30 billion of six-month bills the same day at a rate of 0.15 percent, more than double the 0.06 percent rate on the same maturity securities sold the prior week.
“It’s impressive how quickly we’ve come back from the edge,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 21 primary dealers that trade with the Fed and are required to bid at Treasury auctions.
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