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.” The euro area’s economy emerged in the second quarter from 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.”

JPMorgan Bullish

Bonds issued by Banco Bilbao Vizcaya Argentaria SA and Telefonica SA 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, convertible bonds issued by American Airlines parent AMR Corp. fell below par for the first time in six months after the Justice Department sued to block a merger with US Airways Group Inc. JPMorgan is planning to issue 30-year bonds, its first dollar-denominated benchmark offering of that maturity in 20 months.

Credit Benchmarks

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 0.6 basis point to a mid-price of 74.7 basis points as of 11:50 a.m. in New York, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe Index, tied to the debt of 125 companies with investment-grade ratings, was little changed at 94.6 basis points.

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 0.13 basis point to 18.13 basis points. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

AMR Bonds

Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4.3 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.

AMR’s $460 million of 6.25 percent convertible bonds due October 2014 declined 13.5 cents to 91 cents on the dollar at 11:30 a.m. in New York, Trace data show. The securities earlier traded as low as 89 cents, the lowest level since Jan. 2.

The bonds, which traded as high as 116.125 cents on Aug. 9, have plunged 25 cents on the dollar the past two days, the biggest two-day decline over a similar period since November 2011, when Fort Worth, Texas-based AMR filed for Chapter 11 bankruptcy protection.

Proceeds from JPMorgan’s subordinated notes, which may be rated A3 by Moody’s Investors Service, will be used for general corporate purposes, according to a person with knowledge of the transaction, who asked not to be identified because terms aren’t set. Benchmark sales are typically at least $500 million.

Two former JPMorgan employees were charged today by U.S. prosecutors with attempting to conceal trading losses last year as part of a probe of the bank’s $6.2 billion loss on derivatives trades.

Europe Outpaces

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.

Exiting Recession

“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 edged back to growth last quarter, with gross domestic product expanding 0.3 percent after shrinking for the previous six quarters, the European Union’s statistics office in Luxembourg said today. That exceeded the median estimate of 0.2 percent growth in a Bloomberg News survey of 41 economists.

‘Painful Process’

“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.

Taper Talk

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.”