Record weekly investment-grade total but tone remains cautious

Mon Jan 14, 2013 12:00pm EST

NEW YORK, Jan 14 (IFR) - The US high-grade market set a new weekly volume record last week despite indications that investors and issuers alike are growing increasingly anxious about the months ahead. Last week's investment-grade volume reached US$41.61bn, topping the previous best of US$40.642 that was set in March last year.

But unlike then, when the market tone was buoyant, the current mood is decidedly more sombre, with anxiety mounting as credit indices compress towards more complacent levels, with spread-compression leaving little cushion for error.

"There is an absence of broad momentum in credit mainly because primary supply has been more than expected, and it is hard to be too bullish about spread or rate-tightening when bonds are trading near historic tights," said one senior banker.

The fact that yields were touching new lows is also sucking out enthusiasm towards new issues and momentum in credit trading.

Yields on the Barclays US Corporate Investment Grade Index at the start of Friday were near a record-low yield-to-worst of 2.74% - this compares with 3.80% at the start of 2012.

A CASE OF NERVES

One banker said there was a creeping nervousness about the market at the moment, which was also creating price sensitivity towards forthcoming new issues.

Few new issue names were trading with any specific impetus last week. Comcast's 2.85% 2023s were trading flat versus their pricing of Treasuries plus 100bp, while its 4.25% 2033s were at Treasuries plus 122bp versus their plus 125bp pricing. Ford's 4.75% 2043s were trading at Treasuries plus 191bp versus 180bp at pricing, according to Tradeweb.

A tick-up in Treasury yields - the 10-year is approaching 2% - is luring investors to look at shorter duration and floating-rate bonds, as an additional jump in interest rates could translate into significant losses for those stuck with long-dated bonds.

If interest rates were to revert rapidly to early 2011 levels with a 200bp rise, for example, a Triple B rated corporate bond with a 10-year maturity could lose 15% of its market value, Fitch analysts said in a recent report.

Mindful of that, corporate issuers last Thursday priced eight of 10 tranches with tenors of five years or less, including a single floater. For example, Total Capital Canada Ltd & Total Capital Intl raised US$3.25bn from a four-part offering that comprised a tap of its 0.75% January 2016s, a new US$1bn three-year FRN, a US$1bn five-year and a US$1bn 10-year.

Sumitomo Mitsui Banking Corp's three-part offering also consisted of a three-year, five-year and 10-year, while DirecTV Holdings LLC & DirecTV Co Inc raised US$750m from a five-year and TransCanada PipeLines priced a US$750m three-year. All this follows recent issuance of one and two-year floaters by GE Capital, MetLife, Daimler Finance and RBC.

LOW RETURNS LEAD TO EQUITIES

Returns in the corporate bond markets are also expected to be so low this year - and the threat of rising interest rates so real - that some strategists say investors should start pulling money out of bonds and putting it into stocks.

Investment-grade bonds are expected to provide a mere 1.6%-3% in returns in 2013, down from 9.6% last year and an average of around 12% every year since the credit crisis. Even high-yield returns will plunge to around 3%-7% in 2013, a drop from 15% last year and an annual average of 22% since the start of the crisis.

Meanwhile, the S&P 500 is forecast to produce double-digit returns this year, after 2012 returns of about 13.5%.

"Rising long-term interest rates represent the key risk for investment-grade credit in 2013," said Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, in mid-December.

"Given ultra-low investment-grade yields of 2.75% to start, if 10-year Treasury yields increase to just 2.3% in 2013 - which appears not an outrageously high number - the return on investment-grade corporate bonds next year could turn negative."

Many fixed income portfolio managers lost interest in Single A and higher rated industrial corporate bonds months ago.

"There is no doubt that if rates go up, there is no cushion for those bonds with mid double-digit credit spreads between 30bp and 90bp over Treasuries," said Michael Collins, a senior portfolio manager at Prudential.

"Total returns will be low single digits or negative for a big chunk of the investment-grade market if rates increase, and a lot of people believe that will be the case," he said.

But amid this heightened nervousness in the market about spread-compression, supply/demand imbalances are still providing strong technicals for credit spreads and a supportive backdrop to corporate valuations.

Investment-grade bond funds reported a weekly net inflow of US$2.164bn for the week ending January 9, according to Lipper data. The four-week moving average dataset for both monthly and weekly cash entering the asset class was reported at a rate of US$1.566bn per week.

In the week ended January 9, the weekly only reporting dataset of corporate-high yield reported net investor inflows of US$1.113bn. The four-week moving average for the dataset reports cash leaving the sector at a rate of a negative US$15.3m per week, as measured over four weeks.

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