Fed Sparks Dash for Cheap Debt With December Hike Back on Table

  • Locking in low borrowing costs before end of zero-rate era
  • Microsoft to Norfolk Southern decide `good idea to go now'

The Federal Reserve has lit a fire under corporate borrowers who are again faced with the prospect of an interest-rate increase this year.

Companies from Microsoft Corp. to American Express Co. and Norfolk Southern Corp. rushed back to the bond market to lock in cheap borrowing costs before the central bank ends its unprecedented zero-rate era. Fed Chair Janet Yellen and policy makers signaled this week they remain prepared to raise their key rate as soon as their next meeting starting Dec. 15, pushing the perceived odds of a rate increase to 50 percent.

"The message has been sent that if you have issuance planned, it might be a good idea to go now," said Hans Mikkelsen, head of U.S. investment-grade credit strategy at Bank of America Corp. in New York. "You can’t be sure what the market will look like when the Fed starts to raise rates."

Corporate treasurers are finding a rare window after a tumultuous stretch that left debt investors with the worst losses in four years. After a decline of 2.8 percent for the previous six months, dollar-denominated bonds of companies from the most-creditworthy to the riskiest have gained 0.8 percent in October, according to Bank of America Merrill Lynch index data.

‘Strong Incentive’

Microsoft led the way Thursday with its biggest-ever offering of $13 billion. The seven-part deal eclipsed a mark set just eight months ago by the tech giant as it raises money to repurchase stock and repay existing debt.

American Express raised $1 billion in a two-part deal, while Norfolk Southern issued $600 million of 30-year bonds, its second offering of such debt this year. The issuance is keeping 2015 on pace for a record year, with the 1.41 trillion in dollar-denominated debt sold poised to beat 2014’s record of $1.57 trillion, data compiled by Bloomberg show.

"An earlier rate rise than initially signaled is a strong incentive to issue sooner than later," said Donald Ellenberger, who oversees about $10 billion as head of multi-sector strategies at Federated Investors in Pittsburgh. "There’s been a lot of supply, and there will be more supply coming, there is no doubt about that."

While Fed policy makers on Oct. 28 kept the central bank’s target rate near zero -- where it’s been since 2008 -- they added a reference to the possibility of increasing the rate "at its next meeting" based on "realized and expected" progress in reaching economic-growth goals. They maintained that the economy continues to expand at a "moderate" pace.

Borrowing Costs

U.S. junk bonds have returned 2.7 percent in October, on pace for the strongest month since 2012, Bank of America Merrill Lynch indexes show. Investment-grade issues gained 0.4 percent.

The cost of borrowing relative to government debt has dropped to the lowest in more than a month, down from a more than three-year high at the start of the month, the index data show. That’s setting up for a busy issuance calendar for the rest of the year, according to Barclays Plc.

It isn’t all smooth sailing for issuers. Microsoft had to pay a 0.18 percentage point premium on its $3 billion offering of 10-year notes, more than the yield on its similar maturity debt in the secondary market on Wednesday. Lannett Co. and its bank, Morgan Stanley, are sweetening terms on a $1.2 billion loan deal to lure investors stung by drug-maker debt following a selloff in Valeant Pharmaceuticals International Inc., according to people with knowledge of the matter. High-yield energy debt, plagued by commodity-market woes, is trading at a yield of 11.86 percent after touching a 7.87 percent low for the year in May.

‘Data Dependent’

For Bank of America’s Mikkelsen, a December lift-off isn’t a sure thing because the U.S. economy has yet to return to full strength.

Data Thursday showed gross domestic product, the sum of all goods and services produced in the U.S., rose at a 1.5 percent annualized rate in the third quarter, down from a 3.9 percent pace in the previous three months. Inflation also remains well below the Fed’s 2 percent goal, with its preferred gauge of prices rising by just 0.3 percent in the 12 months through August.

"The Fed will be very data dependent, and it’s clear the U.S. is losing some momentum, " he said.

Barclays’s Mark Bamford pointed to merger-and-acquisition activity at a six-year high, along with the scarcity of alternatives to corporate-bond market, as reasons for issuance to continue at a record pace for the rest of the year.

"The supply demand dynamic still favors the market, and the atmosphere of low growth and low inflation is still good for bonds," said Bamford, the New York-based head of global fixed-income syndicate at Barclays.

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