The Credit Market’s Worst Year Since 1980 Isn’t So Bad
(Bloomberg Opinion) -- The U.S. investment-grade bond market is off to its worst start to a year in more than four decades. Sounds bad, right?
For a sense of the “carnage,” consider the following:
- U.S. corporate investment-grade funds have reported inflows for 18 consecutive weeks, with investors pouring in almost $53 billion so far in 2021, according to Refinitiv Lipper.
- Verizon Communications Inc.’s $25 billion jumbo bond sale on Thursday, the largest deal yet this year, received at least $109 billion of orders.
- On average, corporate bonds yield 99 basis points more than U.S. Treasuries — since the turn of the century, the all-time low is 76 basis points.
- The current average all-in yield of 2.23% would have easily been a record low before the Covid-19 pandemic.
I hope these points make clear that the credit markets are doing just fine. Yes, investment-grade debt has lost 4.4% in 2021, making it the worst-performing of all the key bond markets tracked by Bloomberg Barclays indexes. But the fact that investors have kept their cool, even in the face of a rapid and tumultuous repricing of longer-term interest rates, indicates potentially better days ahead — especially if the rout in U.S. Treasuries loses its momentum.
As Bloomberg News’s Jack Pitcher noted, some corporate-bond investors raised their eyebrows on Wednesday when two companies pulled potential bond offerings, marking the first non-Friday of 2021 that didn’t have a single new investment-grade deal. It followed some signs that the market was fatigued — though even then, it was that borrowers were “only” able to tighten spreads by 18 basis points or so from initial levels, or orders totaled “just” 1.8 times the amount for sale. It’s also worth noting that on that same day, American Airlines Group Inc. sold $10 billion of speculative-grade debt, the largest ever for an airline, so it’s possible other borrowers just wanted to get out of the way, as they also did for Verizon on Thursday.
As it so happens, Verizon’s bond sale epitomizes the reason investment-grade debt has floundered so much this year. The telecom company’s deal was broken into nine parts, including long-duration debt maturing in up to 40 years. These securities are highly vulnerable to rising interest rates — a Bloomberg Barclays index of corporate bonds with an average maturity of 23.5 years has lost more than 8% this year, while an index with a maturity of 4.5 years has declined less than 2%. This is one of the reasons I argued last week that junk bonds are the better shelter from the volatility in benchmark interest rates — investors are only willing to lend to speculative-grade companies for a short period, which keeps the high-yield market’s duration exposure relatively low.
Still, that doesn’t quite explain how investment-grade fund flows have remained so steady throughout the Treasuries tantrum. In truth, it’s probably not all that much different from the reason that Cathie Wood’s Ark Investment Management continues to rake in money even after tumbling from its highs: People like to buy dips. In the case of corporate debt, where yields reflect the expected return, the average bond yielded 1.74% on New Year’s Eve. Earlier this week, that figure rose to 2.29%, the highest since June.
Those kinds of yields are enough to interest pension funds and non-U.S. investors, Mark Lindbloom, a portfolio manager at Western Asset Management, told me in an interview. “The thing that holds them back from buying is the pace of the move,” he said. “If that pace starts to slow, we’ll see changes in behavior.”
At this point, it’s a fool’s errand to call a peak in longer-term yields. It certainly seems as if buyers emerge when the 10-year Treasury note yields 1.6%, or the 30-year bond breaches 2.3%, and auctions of both securities this week were decent if unspectacular. But bond markets have never truly experienced a Federal Reserve eager to let inflation rise above 2% or a federal government that passes a $1.9 trillion relief bill and immediately looks forward to an infrastructure package. Clearly, the fear of inflation or economic growth that exceeds expectations won’t go away anytime soon.
But there’s nothing ominous about the investment-grade bond market’s losses so far this year. These companies stand to benefit about as much as any from a robust U.S. rebound, so it stands to reason credit spreads will remain at least as tight as they are now. And most fixed-income investors will candidly say that they don’t mind a bit of short-term pain like that of the past two months if it means they can lock in higher yields for the longer term. Even if it’s the sharpest in 40 years.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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