Companies have rushed to borrow money in the US corporate bond market in the first week of the year, taking advantage of easier financial conditions as investors scale back their expectations for the path of future interest rates.
In the first seven days of 2023, companies from Credit Suisse to Ford issued $63.7bn worth of US-marketed debt, according to data from Dealogic, compared to a total of $36.6bn in the last five weeks of 2022.
While this week’s issuance is lower than the $73.1bn issued in the first week of January 2022, interest rates have jumped from near zero to a range of 4.25-4.5 per cent since then. This has significantly raised the cost of borrowing, with more tightening yet to come from the Federal Reserve.
Although the cost of borrowing is far higher than it was a year ago, it has dropped since peaking in October as cooling inflation has tempered expectations of how long the Fed will have to keep interest rates high.
This is despite the central bank’s insistence that it will keep interest rates elevated until it reaches its target 2 per cent inflation rate. Treasury yields have fallen as investors bet that interest rates will peak at around 5 per cent in June, bringing yields on corporate debt lower too.
“If the 10-year Treasury stays at these levels for an extended period of time, you will see more issuance come to market. And it’s not just lower levels, it is lower volatility. The more volatility there is in rates, the less corporate issuance,” said Will Smith, director of US high-yield credit at AllianceBernstein.
Issuance is typically high in January, because demand is lower in December as many investors go on vacation. December was particularly slow in 2022 because the holidays were immediately preceded by a high-stakes Fed meeting at which the central bank changed the pace of its monetary tightening.
In the minutes from its December meeting released this week, Fed officials warned that “unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability”.
Several of the issuers this week, including Société Générale and UBS, had initially begun to feel out interest at the beginning of December only to find an extremely slow market, according to a credit investor who wished to remain anonymous because of the confidential nature of the discussions.
The majority of issuance this week was investment grade, with notable offerings from foreign banks with big businesses in the US and just one high-yield offering from Ford, which ranks high on the spectrum of junk ratings.
John McClain, a high-yield portfolio manager at Brandywine Global, said he had low expectations of more high-yield issuance in the coming weeks as the magnitude of the Fed’s next interest rate increase at the end of January is unclear.
“High-yield borrowers are more sensitive to interest rate increases, and so if you don’t have to come to market, you are probably playing a bit of a waiting game,” he said.
Corporate yields have fallen further than those on Treasuries, with the difference between the two — the premium that investors demand to hold riskier corporate bonds over risk-free Treasuries — also shrinking since October. That is typically an indication that investors see lower risk of default, suggesting some have scaled back their expectations for the magnitude of the slowdown in the US economy this year.
“The credit market is clearly telling the equity market: we don’t see a recession, and if we do see one, it will be a mild one,” said Andy Brenner, head of international fixed income at NatAlliance Securities.
But some investors who are persuaded that a recession is coming argued that the lower premiums companies were paying to borrow were not enticing enough for investors, even in the investment-grade market where the risk of default is much lower.
“Spreads are very tight for where we are in the economic cycle, so you need to be selective,” said Monica Erickson, head of investment-grade credit at DoubleLine Capital, who said that of the 34 deals on Wednesday and Thursday, she participated in two.
“Obviously, other people are buying because the deals are getting done, but we’re being very selective in what we buy.”