Corporate debt yields have hit their highest in more than a decade, but some investors still think bonds of US blue-chip companies are a bad bet.
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Their caution stems from the relatively small premium offered by corporate bonds compared to guaranteed government bonds, which are also currently yielding the most generous yields we have seen in the last 15 years. A yield of 5.7% on investment-grade corporate bonds – not seen since 2009 according to the Intercontinental Exchange (ICE) index – attracts investors less than a yield of just over 5% on some treasury bonds.
When the prevailing expectation on Wall Street is for a recession, according to some investors the compensation in purchasing corporate bonds, or the margin against government bonds, is insufficient. According to Chip Hughey, director of fixed income products at Truist Advisory Services, “Given the challenges facing the economy this year, The debt spreads look too tight.”
Defaults in investment-grade corporate bonds are still extremely rare, but the main risk is that an increase in the central bank’s interest rate or a weakness in business conditions could push down the prices of the bonds in the market, to the point that investors would want to sell them before they reach maturity.
Still, cautious investors say the risks are rising, especially given the expectation that persistent inflation will force the Federal Reserve to continue its rate hikes. Pessimists point out that the housing market has slowed, corporate profits are down compared to the fourth quarter of 2022, and that it may be months before the chilling effects of the Fed’s rate hikes reach the economy itself.
As the scenario of a recession becomes more and more likely, investors expect that the spreads in the corporate bonds will widen, which will hurt their holders in view of the gap with the prices of the treasury bonds.
About 150 billion dollars were raised
Investment-grade corporate bonds were among the worst-performing major US investment avenues in February, returning a negative 2.91%. This compares to a 2.4% drop in the S&P 500 index and a negative yield of 1.3% in junk bonds.
At the same time, the bond raisings swelled, and last month new bonds with high ratings were issued in the largest volume ever recorded in February. Among these we can mention issues of blue chip giants such as UPS and AT&T, which contributed to the raising of almost 150 billion dollars of high-rated debt.
Investment-rated corporate bonds currently offer a yield that is 1.27 percentage points higher than that of a corresponding treasury bond, according to ICE data.
Despite concerns that spreads could widen, one source of relative stability in the bond market has been consistent demand from long-term institutional investors, such as insurance companies and pension funds, for whom corporate bonds are the mainstay of the portfolio, explained Natalie Trevithick, director of credit strategy at Payden & Rygel. Such investors focus more on the total returns than on the variable margins, and from this angle the bonds look attractive at current prices, according to her.
The year-to-date decline in new investment-grade bond issuances also helped support prices in the face of reduced available supply. In 2022, high-grade bond issuances fell 16% as companies faced higher borrowing costs, according to industry association data The stock market and the financial markets. January resulted in another 15% decrease in new issuances compared to the corresponding quarter last year.
But the trend changed last month, as new bonds issued by companies such as Philip Morris, Waste Management and pharmaceutical company Amgen met with increasing demand. All of this led to the largest volume of borrowing ever in February, according to Leveraged Commentary & Data, driven by concern among corporate finance managers. Grant that financial conditions will become more challenging.
In the latest wave of issuances, 30-year bonds stood out, enjoying record demand from long-term investors, who were happy to ‘lock in’ yields of over 5% for the next three decades.
High rating? dear to us
Some are now expecting a slowdown in debt issuances, after the February raisings answered the upcoming financing needs of many companies. Bank of America is even predicting the weakest March in investment-grade bond issuances since 2019.
And treasury bonds are not the only competition of corporate bonds for debt investors who seek to balance risk with profit. To some, high-rated bonds seem expensive compared to junk-rated ones.
Low-rated companies aren’t necessarily much safer than those with a sub-investment grade, but they are available at a more generous discount to their price, explained Jay Hatfield, CEO of Infrastructure Capital Advisors. “We prefer BB over pure investment grade,” Hatfield demonstrated. “There is currently too much of a gap between the yields on weak BBB and BB-rated bonds.”