Bloomberg News

Fed Muffling Taper Talk Spurs High-Grade Revival: Credit Markets

August 12, 2013

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American International Group Inc. (AIG) offices in New York. Photographer: Scott Eells/Bloomberg

Investment-grade corporate bonds are showing signs of life following the biggest losses since 2008 as concern wanes that a Federal Reserve pullback from record stimulus will cause a surge in interest rates.

Mutual and exchange-traded funds that focus on dollar-denominated, high-grade notes reported $639 million of deposits in the week ended Aug. 7, the most in more than two months, according to Bank of America Corp. Relative yields on the debt have retraced more than half of an increase that pushed them to a nine-month high in June after Fed Chairman Ben S. Bernanke laid out a timeline for the Fed to begin slowing bond purchases that have bolstered credit markets.

Bonds sold by American International Group Inc. (AIG:US) and Morgan Stanley (MS:US) are leading gains of 1.7 percent since the peak in yield spreads as Fed policy makers stemmed a jump in long-term interest rates by stressing they will remain accommodative even if they start scaling back stimulus. With relative yields still more than historical averages, bond buyers have a cushion from climbing rates, according to Wells Fargo Advisors LLC analysts.

“The Fed did a good job in convincing the market that tapering isn’t necessarily tightening,” Ashish Shah, the head of global credit at AllianceBernstein Holding LP, which manages $435 billion in assets, said in a telephone interview. “The stability we’re seeing in Treasuries is helping people come back into the market to find pretty attractive yields.”

Bond Withdrawal

Investors are adding to bond funds after pulling a net $8.3 billion over the past 10 weeks, the biggest withdrawal from the asset class over a comparable period since 2009, according to Bank of America strategists led by Hans Mikkelsen. High-yield funds attracted $566 million of cash in the period ended Aug. 7 after an outflow of $582 million the previous week.

The extra yield investors demand to hold U.S. company bonds rather government securities has contracted 19 basis points since reaching a nine-month high of 172 on June 24, according to the Bank of America Merrill Lynch U.S. Corporate Index.

“There are signs of life,” Scott Colyer, chief executive officer of Monument, Colorado-based Advisors Asset Management, which oversees about $11.6 billion in assets, said in a telephone interview. “People are expecting tapering and are getting out of Treasuries” and into higher-yielding assets.

Credit Benchmarks

Elsewhere in credit markets, Dole Food Co., the fresh fruit and vegetable producer, obtained a $1.15 billion financing commitment to support the company’s buyout by Chairman and Chief Executive Officer David H. Murdock. Viacom Inc. (VIAB:US), the owner of the Paramount film studios and cable networks Comedy Central and BET, is planning to sell benchmark debt in three parts.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, rose 0.2 basis point to 75.6 basis points as of 11:19 a.m. in New York, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe Index of credit-default swaps tied to the debt of 125 companies with investment-grade ratings fell 0.2 to 95.8.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.

Dole Financing

Bonds of San Francisco-based Wells Fargo & Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.5 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Deutsche Bank AG, Bank of America, and Bank of Nova Scotia are arranging the debt for Dole, the Westlake Village, California-based company said in a regulatory filing today.

Murdock is acquiring all outstanding shares of Dole for $13.50 in cash per share in a transaction valued at $1.6 billion, the company said today in a statement distributed by Business Wire. The deal, which is expected to close during the fourth quarter, will also be financed with equity contributed by Murdock.

Viacom Offering

Viacom may issue five, 10- and 30-year debt as soon as today, according to a person with knowledge of the transaction. The bonds may be rated Baa2 by Moody’s Investors Service.

Bank of America, Citigroup Inc., JPMorgan Chase & Co. and Royal Bank of Scotland Group Plc are managing the offering for the New York-based company, the person said. Proceeds will be used for general corporate purposes. Benchmark sales are typically at least $500 million.

Bernanke sent Treasury yields to the highest level in almost two years after outlining a plan June 19 in which the Fed could start curtailing the current pace in $85 billion of bond purchases later this year and end them around mid-2014 if growth is in line with the central bank’s estimates. He helped calm bond buyers July 17 when he told the House Financial Services Committee that the asset purchases “are by no means on a preset course.”

Yields on 10-year Treasuries, which ended last week at 2.58 percent, climbed 111 basis points to 2.74 percent from May 1 to on July 5. The jump increased a measure of price swings to 117.9, the highest level since December 2010, according to the Merrill Lynch Option Volatility Estimate MOVE Index, The index, which has averaged 67.4 this year, ended last week at 75.4.

Earnings Surprises

“When volatility in Treasuries increases as we’ve seen in the last few months, people tend to flee fixed income,” Greg Tornga, who manages $7.5 billion as head of fixed income at Edge Asset Management in Seattle, said in a telephone interview. “When volatility is low, they get more comfortable and come back.”

Bond-buyer confidence is being bolstered by better-than-estimated corporate profits. Companies in the S&P 500 Index (SPX) reported second-quarter earnings that on average were 2.8 percent higher than analyst estimates, according to data compiled by Bloomberg from the 449 firms that have reported earnings.

Moody’s on Aug. 9 lowered its projection for the global default rate among speculative-grade companies by year-end to 3 percent from a 3.2 percent estimate last month, according to a report from the New York-based credit grader.

AIG Dividend

AIG, the insurer that repaid a U.S. bailout last year, declared its first dividend since the rescue after saying Aug. 1 that profit jumped 17 percent in the second quarter. Net income rose to $2.73 billion from $2.33 billion a year earlier, the New York-based firm said in a statement.

AIG’s $23.5 billion of bonds included in the Bank of America Merrill Lynch U.S. Corporate Index have returned 3 percent since June 24.

Morgan Stanley, owner of the world’s largest brokerage, reported second-quarter earnings that beat estimates and said it will buy back $500 million in shares.

The bank’s $57.2 billion of bonds in the Bank of America Merrill Lynch index have gained 3.4 percent since June 24.

“Financials have more room to run in terms of tightening,” said Bradley Rogoff, head of global credit strategy at Barclays Plc in New York. “Absolute yield levels are starting to look more attractive compared to where they were earlier in the year.”

Keeping Short

Yields on dollar-denominated investment-grade bonds fell to a record low of 2.65 percent on May 2, Bank of America Merrill Lynch index data show. They have since risen to 3.32 percent.

While relative yields on the notes have contracted 4.51 percentage points since the end of 2008, they are still 32 basis points higher than the average during the decade ended Dec. 31, 2006, according to the data.

“In the current environment, our only overweight recommendation in taxable fixed-income is for investment-grade rated corporate bonds,” Pat McCluskey, a senior fixed-income strategist at Wells Fargo Advisors, wrote in an Aug. 6 report.

He said investors should focus on shorter-maturity bonds from the most-creditworthy borrowers as these notes are less sensitive to both rising interest rates and higher default rates.

“This is not the type of environment in fixed income where you want to hit a home run,” McCluskey said in a telephone interview. “You want to protect your portfolio.”

To contact the reporters on this story: Matt Robinson in New York at mrobinson55@bloomberg.net; Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • AIG
    (American International Group Inc)
    • $54.52 USD
    • 0.04
    • 0.07%
  • MS
    (Morgan Stanley)
    • $31.41 USD
    • -0.27
    • -0.86%
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