US corporate bonds have worst start to year in decades
Negative returns reflect rising interest rates and issuance by weaker borrowers
High-quality US corporate bonds had their worst start to a year in at least two decades, as interest rates rose and companies continued to tap the capital markets in significant numbers.
Investors holding corporate bonds with investment-grade ratings had lost 3.8 per cent by the end of last week, according to ICE BofAML Indices, as the Federal Reserve raised rates and shrank its presence in the bond market.
A reduction in the supply of new corporate bonds, which many had predicted at the start of the year would prop up prices, has not been as sharp as expected this year, because while technology companies retreated, companies with lower credit ratings came to market in their stead.
Without the tailwind of shrinking supply, investors have been hammered by the effects of rising US Treasury yields, said Peter Tchir, head of macro strategy at Academy Securities.
Negative returns have been most pronounced in the highest-grade corporate bonds, which borrow at rates closest to those on risk-free Treasuries and which, because of their longer average maturities, are most sensitive to interest rates.
“The bulk of what’s driving this is the move in interest rates, which has been pretty extreme,” he said. Last week, the 10-year US Treasury yield climbed above 3 per cent to its highest level since 2011. Bond prices move inversely to yields.
High-yield bonds, where trading is less sensitive to rates and more closely tracks perceptions of credit risk, had lost just 0.3 per cent for the year to last Friday.
In investment-grade bonds, credit risk is seen as having declined modestly since the start of the year — although since a nadir in February, when the yield spread over Treasuries reached its lowest in nearly 20 years, spreads have climbed 25 basis points, according to ICE BofAML indices.
With wider spreads and higher Treasury yields coming simultaneously, the 100-day performance of US corporate bonds — that is, returns since mid-February — has been the third worst of any period since 2000, JPMorgan strategists said in a note on Friday.
Spreads have widened in part because there has been a shift in the types of companies selling investment-grade debt to investors.
The tech sector’s bond issuance is down 81 per cent compared to this time last year, according to Dealogic, as changes to US tax law allowed them to tap their offshore cash for activities they would previously fund with borrowing.
But borrowers in the food, beverage, retail and metals industries have all sold at least twice as much debt as they did last year, according to Dealogic. The overall decline in corporate bond issuance year to date — 8 per cent, according to Dealogic — has been smaller than expected.
“Investment-grade issuance has still been fairly aggressive, even though it’s down,” said Max Gokhman, head of asset allocation with Pacific Life Fund Advisors. “We’re definitely concerned about IG.”
The US tax changes have also encouraged tech companies to shrink their pile of bond investments, reducing a potential source of demand for corporate bonds that could counter the price pressure from rising rates and robust supply.
“With only a small . . . decline in supply volumes this year, no wonder the technicals of the high-grade market have been challenging,” wrote Hans Mikkelsen and his team of strategists at Bank of America Merrill Lynch.