Hot bond market spurs debate about bubble

Mon Oct 22, 2012 2:27pm EDT

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Oct 22 (IFR) - US bond issuance in 2012 topped the USD1trn mark last week, pushing the year's total closer to the all-time record in 2007 - set just before the global financial crisis kicked in.

And the state of the red-hot market, driven by the Federal Reserve's low-rates policy, is the subject of equally hot debate over whether we are in the same kind of bubble five years on.

"This is a Fed-engineered market bubble which is getting bigger, with investors hunting for yield taking more risk on the assumption that the crisis in Europe has been fixed, which is debatable," said a senior banker at a US bank.

"I don't see in the near term any catalyst that will burst this building bubble, where each deal is priced tighter than the one before - and demand is touching new highs."

But others insist that while 2007 saw new issues funding mergers and acquisitions, current new issuance is aimed primarily at refinancing debt.

"It has been an extraordinary year, characterized by less volatility and fewer unforeseen circumstances than previous years," said Mark Bamford, head of global fixed income syndicate at Barclays.

"The net new money raised in such an environment has been much less than in 2007," he said.

"A large amount of 2012 debt was raised to refinance existing debt at lower cost. The market has received this financing well, as it has been seen as prudent and not overwhelming in amount, despite the high nominal volumes."

ANOTHER YEAR OF LIVING DANGEROUSLY?

New issuance in 2012 stood at USD1.061trn as of October 18 - just USD67bn away from the 2007 record with more than two months to go.

The year has been dominated by a rush to buy US bonds, whether junk or investment grade, with issuers enjoying some of the best primary market conditions ever.

So far in 2012, low-coupon records have been set across the spectrum from one-year to 30-year tenors, while new issue concessions have touched up to negative 90bp.

According to the Barclays US IG industrials index, the yield to worst hit a new low of 2.625% as of October 19, while the US IG corporate index was at 2.68% - almost the all-time low of 2.67%.

Those rock-bottom rates have tempted issuers to bring forward refinancing of their debt holdings, and some companies have so much cash they are buying structured finance products - and even bonds issued by other companies.

The increased access to cheap debt has also lured some to fund share-price supportive actions through bond issuance - just as in the pre-crisis years.

While many analysts said the leverage-building exercises to support share prices are not as alarming as back then, companies with huge cash piles are being nudged in that direction.

"We are constantly telling issuers to take advantage and issue bonds, because these conditions are too good to last," said another senior banker.

"For now, the markets seem to be ignoring any potential for a significant downturn in the global economy. So that increases the risk that if the economic backdrop deteriorates, everybody will be hosed."

But Bamford said that the doomsday scenarios have been predicted every year in the last five years as the Federal Reserve has extended its zero-rate policy, injected liquidity into markets and pushed investors towards purchasing debt issued by companies refinancing existing liabilities.

"Each year for the past several years, we've heard a familiar refrain that the end of the credit cycle was upon us, but that continues to be an unlikely outcome," Bamford said.

"With accommodative central banks, cash-rich corporates selectively refinancing, benign inflation and tepid economic growth, spread products will continue to grind tighter."

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