Long Trade in Corporates Brings Pain as Central Banks Deliberate

  • Longer-dated corporate bonds have fallen 2.9% since August
  • "We’ve had a very good run here," says Loomis fund manager

Investors are cooling on one of the hottest U.S. corporate bond trades this year.

Corporate bonds maturing in 10 years or more have fallen 2.9 percent in September, according to Bloomberg Barclays index data, a drop that is nearly five times as large as the broader bond market’s decline and that erases some of the double-digit gains of the previous eight months. On Monday, Shire Plc became the first company this year to sell more than $10 billion of bonds without including any 30-year debt, according to data compiled by Bloomberg. 

Demand for longer-term corporate debt is slackening as some investors grow increasingly concerned about potential upcoming central bank moves. Many market participants are speculating the Bank of Japan will take steps on Wednesday to lift long-term yields. If so, Japanese fund managers might buy fewer U.S. long-term bonds, and more domestic debt. The U.S. Federal Reserve is meeting on Tuesday and Wednesday, and while few fund managers expect it to lift rates this week, it could give more clues about when it will resume tightening. 

“Long bonds are not as compelling as they were back in February,” said Neil Burke, a money manager at Loomis Sayles & Co., which manages about $240 billion in assets. "We’ve had a very good run here." His firm has taken profits on some of the debt.

The securities also look more expensive by at least one measure. An investor that in February bought longer-term corporate bonds could earn nearly 3 percentage points more yield than on equivalent Treasuries, according to Bloomberg Barclays index data. Now that figure is closer to 2 percentage points.

Fed Chair Janet Yellen said in August that the case to raise interest rates has grown stronger, and two of the Fed’s preferred bond-trading partners are forecasting that the central bank will resume tightening this week. Whenever the Fed resumes hiking rates, longer-term bonds could be hurt. During Fed tightening cycles in the 1990s -- and again in 2006 -- prices for longer-term securities fell more than those for shorter-dated debt. 

"The 30-year part of the curve obviously doesn’t benefit from a lot of volatility," said Todd Mahoney, head of fixed-income syndicate for the Americas at UBS Group AG in New York. Longer-term bonds have been less oversubscribed in recent deals than they were earlier this year, he added. Big fixed-income investors including BlackRock Inc. and DoubleLine Capital have cautioned recently that rising inflation could hurt longer-term Treasury debt, the benchmark for corporate debt.

The average maturity for new bonds sold so far this month has dropped to 9.5 years, from 11.3 in August, according to Bloomberg data.

Even with recent declines, long-dated bonds are still up more than 14 percent for 2016 through Monday’s close, including price gains and interest payments. That compares with a 6.3 percent increase for the S&P 500 on a total return basis during that period, and a gain of 5.2 percent for the Bloomberg Barclays U.S. Aggregate index.

Companies haven’t stopped issuing 30-year notes -- energy explorer Hess Corp. sold $500 million of the debt on Monday for example. And some fund managers keep buying it-- early on Monday, for example, investors purchased a passel of longer-term U.S. corporate bonds, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Foreign central banks have played a role in recent declines in long corporate bonds. More than $10 trillion of debt globally, mostly in Europe and Japan, has negative yields, which has spurred many investors to buy U.S. dollar bonds. Investors outside the U.S. purchased $146.3 billion of dollar-denominated corporate debt in the 12 months through July, according to U.S. Department of the Treasury data. Any slackening in that demand could hurt U.S. corporate bond markets, said Craig Bishop, a Minneapolis-based strategist for RBC Wealth Management’s fixed-income strategies group.

“Central bank fears raised their head,” Bishop said. "Investors got nervous."

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