The US Federal Reserve has sent a shudder through the global corporate bond market. As yields on US Treasuries have risen ahead of a planned slowdown in Fed asset purchases, or “quantitative easing”, companies’ debt issuance has recently slowed significantly.
For the first part of the year, corporate debt sales surged to record levels as companies took advantage of historically low interest rates to refinance borrowings or raise capital. Investment grade issuance in the first seven months of the year exceeded $1tn worldwide. Apple, US maker of the iPhone, highlighted the global appetite for low cost capital market funding when it sold bonds worth $17bn in April.
This month, however, issuance has fallen to August lows not seen for five years, with just $65bn in new investment grade corporate bonds, down from $121bn in the same month a year ago.
Bankers are optimistic the drop is just a seasonal lull. But with financial markets still volatile – especially in developing economies – and investors nursing losses on bond portfolios, the outlook looks distinctly less certain than even a few months ago.
“Companies front-loaded a lot, so they have the luxury of waiting,” says Richard McGuire, bond strategist at Rabobank. “At the very least, it would pay for them to bide their time and see whether the increase in yields is temporary, or a more lasting phenomenon.”
When companies have issued recently, they have moved towards shorter term bonds or bonds with variable interest rates, which are more attractive to investors when future borrowing costs are uncertain.
Olivia Frieser, head of credit research at BNP Paribas, says: “Companies have a lot of cash and have pre-funded to a significant degree but we could see additional, opportunistic issuance. Rate expectations will be key.”
A crucial date is the Fed’s two-day policy meeting starting on September 17, when more guidance is expected on the future of quantitative easing.
What happens after that will depend largely on how smoothly the Fed is able to manage the market re-pricing and, in turn, investor demand. Rises in yields, which move inversely with prices, reduce the value of portfolios – but offer better future returns.
“Providing the pick-up in yields is orderly enough then you would be hoping that investment and pension funds will step back in and take advantage of higher yields and steady things. That is broadly what is happening at the moment,” says Matt King, credit strategist at Citigroup.
Slower bond issuance could even push up secondary market prices by creating “scarcity”, adds Jim Sarni, managing principal at Payden & Rygel, the investment manager. “If sentiment continues that rates will rise as overall supply will go down, that could make long-term bonds even scarcer,” he says.
“There’s a large group of investors who need long-term bonds, such as pension funds and insurance companies. That means that in the end, long-term bond prices may do better than people expect.”
The risk is that investors are frightened off by further, abrupt rises in interest rates. Mr King says: “Were the rise in US Treasury yields to accelerate or become disorderly, there is a chance that long term investors will change their minds and outflows from total return funds may dominate.”
Against that background, bankers argue companies will not wait long before re-accelerating issuance. “A lot of issuers realise they’ve missed a window after this huge move in the last three months, and in six months time they don’t want to be in a situation where they’ve missed another window – they want to take advantage of what are still rates well below the long term average,” says Mark Lewellen, head of European debt capital markets at Barclays.
In the US, the pick-up in economic growth is encouraging releveraging by companies, and the country’s debt markets have become more attractive for investors worried about the outlook for emerging market debt.
In Europe, the long term trend away from bank loans for corporate financing is unlikely to be broken. “Bank deleveraging is forcing a lot of companies into capital markets and infrastructure spending will have to be financed increasingly from institutional investors, a trend we are seeing clearly already,” says Bryan Pascoe, global head of debt capital markets at HSBC.
In emerging markets, demand could remain supported by investors’ eagerness to diversify, argues Mr Sarni. “As for companies in emerging markets, they still need capital, perhaps even more now, so I don’t expect a complete shut down for them.”
Additional reporting by Christopher Thompson