Corporate debt suffers ‘indigestion’ as uncertainty disrupts market

Source: ICE Data Services;  Graphic: Axios Visuals
Source: ICE Data Services; Graphic: Axios Visuals

The investment grade (IG) corporate bond market typically gives off safe and boring vibes. This year, not so much.

Why is this important: The multi-billion dollar deep IG market is where America’s largest and most creditworthy companies borrow money. But just like in the mortgage market, where extreme rate volatility is wreaking havoc on both borrowers and lenders, things have also gotten chaotic under the hood of the IG market.

  • Average total returns on IG (also called high quality) bonds were negative 14% in the first half of the year, one of their biggest losses in history, according to a BofA research note .
  • New issuance in this market plunged in the second quarter by 42% from the first quarter and 27% from the second quarter of last year, according to Leveraged Commentary & Data (LCD).
  • There have been at least two weeks with little or no show in the past two months. “It’s unusual,” says Yuri Seliger, credit strategist at BofA.

State of play: Typically, as benchmark Treasuries move, so do blue chip company yields.

  • ICE Data Services’ MOVE Index, which tracks Treasury volatility much like a VIX for the bond market, has climbed this year to levels near their early pandemic highs (see chart above).

So for investors who need to trade higher quality bonds, it has become much more difficult there.

  • Bid and ask gaps – the gap between the bidder’s and the seller’s asking prices – have widened significantly.
  • Fundamentally, the dealers who typically step in to fill that gap — by committing capital to temporarily hold some of the bonds — are unwilling to hold as much inventory as before. This exacerbates price swings, Matt Brill, head of North America investment quality for Invesco Fixed Income, told Axios.

What they say: Brokers “find it very difficult to source the paper their clients want to buy,” says Josh Lohmeier, investment grade portfolio manager at Franklin Templeton.

  • “And at the same time they are having great difficulty finding accommodation for the bonds that their clients want to sell. The indigestion of not being able to do anything is very difficult at the moment,” he says.

Dealer inventories IG bonds were just $2.1 billion as of June 29, significantly lower than most of the past nine years (they were as high as the $10 billion zone at the end of last year) , according to a BofA analysis of Federal Reserve data.

  • The reduction stems from post-financial crisis regulatory capital changes for banks that have been phased in over time – and are now colliding with the market sell-off, says Tony Roth, chief investment officer at Wilmington Trust.

Meanwhile, for business who want to tap into the funding market, the problem is not just a higher cost of capital compared to, say, six months ago.

  • Volatility also means that if they want to put a deal on the market on any given day, their bankers may or may not be able to sell it as expected – and it’s not a pretty sight if a deal falls through.
  • Example : Tech giant Oracle has long been expected to tap the bond market to fund its acquisition of Cerner, but its bankers still haven’t pulled the trigger. The acquisition has already been finalized, relying for the moment on short-term bridge financing.

The bottom line: So far, these lock-ins have been largely rate-driven. They will only get worse if the economy goes into recession and real credit quality starts to deteriorate.

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