Investors Get Back Into Corporate Bonds
While bonds were out of favor for several months, many are now seeing better value in debt markets
Investors are going bargain hunting for beaten-down corporate bonds.
That is a reversal from earlier in the year, when investors sold off even the highest-quality debt. The turnaround highlights the tensions pressuring financial markets. In recent weeks, investors have grown more confident about the Federal Reserve’s path for raising interest rates to wrangle inflation—and more worried that, as a result, growth has begun to slow.
In May, as traders bid up bond prices, debt tracked by the Bloomberg U.S. corporate-bond index handed investors a roughly 0.7% return for the month, counting price changes and interest payments. That was the first time in 10 months that holding corporate bonds kept investors in positive territory.
Bond markets have had a rough year. Red-hot inflation makes the fixed payments offered by most debt investments less appealing. The Fed has been raising interest rates to try to cool the economy and fix inflation, but that has made investors demand higher returns for holding bonds, pushing down bond prices. The Fed is also unwinding its pandemic bond buying, which could suppress bond prices further.
But in the past few weeks, investors have started giving bonds another look, including corporate debt as well as U.S. Treasurys and mortgage-backed debt. Some investors prefer to buy the debt of blue-chip companies, such as AT&T Inc. or International Business Machines Corp. , because it offers higher returns than government bonds but with relatively little additional risk.
For some money managers, bond prices fell to levels too good to pass up in recent weeks. Others are looking for an alternative to stocks, which have had an equally bumpy few months.
The S&P 500 is down 14% this year. Stocks finished lower last week, with the S&P losing ground for the eighth time in nine weeks. The Labor Department said Friday that the U.S. added jobs at a strong but slower clip in May, and the Fed is closely monitoring jobs data as officials decide how to set benchmark interest rates in the coming months. One point of concern is that a strong labor market will further elevate inflation.
The debt of U.S. companies with relatively strong financial profiles is offering investors yield premiums, or spreads, of about 1.31 percentage points greater than what Treasurys offer, according to index data from Bloomberg. That number was as high as 1.49 percentage points a couple of weeks ago, but it has edged down as more investors seize on corporate debt as an alternative to the swooning stock market.
The spread was 0.92 percentage point at the end of 2021.
As inflation escalated rapidly earlier this year, so did investors’ guesses about how fast and how high the Fed would raise interest rates. That slashed the appeal of bonds because it suggested that higher yields on fixed-income investments would be available in the near future.
Now, higher yields have arrived. Inflation, meanwhile, edged down slightly in data released last month, and the Fed signaled that it plans to stay the course with the rate increases it had previously telegraphed. Some investors’ concerns have shifted more to the trajectory of economic output.
“A story began to build in the markets that now it was time to get more worried about growth than inflation,” said Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management.
With the outlook for Fed policy over the rest of the year stabilizing, conditions for investing in corporate debt have ripened, said Matt Brill, the head of U.S. investment-grade credit at the asset manager Invesco. That has reduced the premium that investors demand for buying corporate bonds instead of putting their money in Treasurys.
“We’ve switched from playing more defense to at least being neutral and looking for offense,” Mr. Brill said. “The early parts of the year were about survival, but with where yields are and where spreads are, we feel more positive on the overall market.”
The uptick in bond prices mirrors a trend that has played out elsewhere in investment-grade credit markets, with buyers gaining confidence that higher yields and spreads are offering good compensation for the risks that could come with an economic slowdown. The higher spreads also make investors more willing to take on the risk of holding fixed-payment bonds even while rates are rising.
Government bonds rallied last month too. The yield on the 10-year Treasury note fell to 2.842% at the end of May, from 2.885% at the end of April, ending a five-month streak of losses for Treasurys. On Friday, the 10-year yield reversed course somewhat, climbing to 2.955% as traders digested the latest employment data. There have also been signs of growing appetite for bonds tied to government-backed mortgages.
May’s trading wasn’t the first time this year that investors piled into corporate bonds. In the second half of March, traders hit the buy button, and spreads fell rapidly, only to reverse course and move higher again in April. Arvind Narayanan, the co-head of investment-grade credit at Vanguard, said that the previous swing was mostly driven by technical factors in the corporate-bond market.
This time around, Mr. Narayanan said, smaller bond premiums likely reflect a genuine change in the economic outlook. That has given his funds and many others the confidence to jump back in as a buyer.
“We have deployed capital because we felt we don’t think a recession in the U.S. is imminent,” Mr. Narayanan said.
Another factor driving tighter corporate-bond spreads in recent sessions has been a notable dearth of new high-quality bonds for sale to investors by corporate issuers in the midst of the recent market volatility. Through last week, there have been 14 weekdays in 2022 when no companies with investment-grade credit ratings issued new bonds, said Daniel Krieter, a fixed-income strategist at BMO Capital Markets. That is the highest number of issuance-free days through the first five months of a year since 2015, he said. (The statistic excludes Fridays and the days of Fed board meetings, when issuance is usually light.)
With fewer new bonds coming to the market, the same pool of investors goes bidding for the limited debt that is up for sale, driving up prices and pushing spreads lower.
In all, corporations with credit ratings of BBB or better issued less than $100 billion of new debt last month, compared with close to $150 billion in a more typical May, Mr. Krieter said.
In a sign that corporate-credit markets could remain sleepy, the ratings firm S&P Global suspended its forward-looking financial guidance Wednesday, citing a slowdown in new bonds to rate.
“Debt issuance volumes have been extraordinarily weak year-to-date,” S&P Global said, projecting that the issuance of rated bonds could fall by up to 35% in 2022.
