Flatter Yield Curve Is Bad News for Corporate Bonds, BofA Says

(Bloomberg) -- The inflation fears that have clobbered short- and intermediate-term U.S. Treasury notes this month could spell trouble for credit markets, according to Bank of America Corp. strategists.

Worries about rising inflation have shrunk the gap between shorter- and longer-term Treasury yields. That kind of yield curve flattening historically hurt investment-grade corporate bond returns, strategists wrote in a report this week that makes the direct opposite call that JPMorgan Chase & Co. made this week.

BofA expects risk premiums to widen substantially for intermediate maturities, and thinks spreads will widen overall. The average spread on the Bloomberg U.S. Corporate Investment Grade Index stood at 85 basis points at Tuesday’s close, near the narrowest level for the year of 80 basis points in June. 

A flatter yield curve gives investors relatively less compensation for buying longer-term bonds like high-grade company debt instead of shorter- or intermediate-term notes, Bank of America said. A less steep curve also tends to increase hedging costs for foreign investors, reducing their demand for U.S. corporate debt, the strategists wrote. Those costs have already started rising for euro- and yen-based investors.

The difference between 5-year and 30-year Treasury yields reached about 85 basis points this week, the narrowest since April 2020. It’s since widened a bit to 96 basis points, but the curve is still substantially flatter than its 157 basis point level in May. 

JPMorgan Chase & Co., meanwhile, expects high-grade bond spreads to “tighten modestly” into the end of the year. 

“Slower earnings and GDP growth from supply disruptions reflect strong demand (a positive) and are not a negative for credit spreads as the demand will be delayed in most cases rather than reduced,” strategists led by Eric Beinstein wrote. 

Elsewhere in credit markets:

Americas

Three U.S. investment grade deals are in the market Wednesday: Bank of New York Mellon, Norilsk Nickel, and Taiwan Semiconductor Manufacturing Co. 

• In high yield, insurance broker Alliant Holdings is set to price a $925 million, multipart bond sale as primary debt markets remain hot
• Commitments on at least four U.S. leveraged loan sales are due Wednesday, including network storage company Anthology’s $1.8 billion deal that backs its acquisition of education technology firm Blackboard
• Commitments for mixed-martial arts promoter UFC’s $600 million loan are also due. The loan will fund a distribution to its parent company for general corporate purposes
• Carnival Corp. sold a junk bond Tuesday that was increased to $2 billion, just over a week after the cash-burning cruise operator boosted the size of a leveraged loan deal that helped the company slash its borrowing costs
• Puerto Rico’s House of Representatives approved a bill late Tuesday that allows the commonwealth to issue new bonds to replace existing debt and cut its obligations, a key step that moves the island closer to resolving its record bankruptcy
• For deal updates, click here for the New Issue Monitor
• For more, click here for the Credit Daybook Americas

Europe

A total of 16 deals were sold in the primary market on Wednesday, including Italy’s 5 billion euro ($5.82 billion) green bond tap. 

• Investors hunting for returns in an era of low interest rates risk causing a financial crisis down the road, according to European Central Bank Governing Council member Robert Holzmann.
• At least four new mandates were announced, including multi-currency carbon-neutrality themed bonds from Industrial and Commercial Bank of China Ltd.

Asia

China cut its borrowing costs on a $4 billion bond sale, in a sign that concerns have eased over risks of contagion from a debt crisis at a major developer. 

• The Ministry of Finance priced the four-part note offering at yield premiums over Treasuries that were lower than the initial indications in marketing
• Lotte Corp., a holding company of Lotte Group, is planning to sell yen-denominated notes as well as dollar bond to help refinance its maturing debt. If issued as planned, the yen note will be the first Samurai bond sold by a South Korean issuer since 2019
   

©2021 Bloomberg L.P.