NEW YORK, March 21 (IFR) - Borrowers are being warned that
the days of insatiable demand for their short-dated corporate
bonds are numbered, now that Fed Chair Janet Yellen has in
effect given next April as a date when the Fed could start
Treasury yields gapped out by as much as 16bp at the short
end on Wednesday, after Yellen said six months was about the
time after tapering ends that the Fed might start to hike the
Federal Funds rate.
If the Fed continues the current pace of tapering its bond
purchases, then September/October could be the time when it has
exited its stimulus program altogether. Six months from October
is April next year.
Although corporate bond spreads barely moved on the news,
many strategists believe corporate cash managers and retail
investors who have parked hundreds of billions of dollars at the
short-end of the corporate curve are still in a state of denial.
"The front end of the credit markets has attracted a huge
amount of inflows over the last six to nine months and is now a
very crowded trade," said Jason Shoup, head of investment grade
credit strategy at Citigroup.
"I'm not saying that investors at the front-end will lose
their shirts as rates rise. But if you are among the many
investors who have been using the short-end of the curve as a
cash substitute or a safe haven from duration, then losing
anything will be a shock."
In the year to-date, corporates have sold almost USD150bn at
five-year tenors and shorter - more than half of all US dollar
investment-grade bonds issued, according to IFR data.
Order books in multi-tranche deals have also been
overwhelmingly skewed towards shorter-dated bonds, and issuers
have been virtually guaranteed access to the market even during
the worst risk-off days if they have been willing to tap the
pool of demand for shorter-tenor instruments.
"The front end may not be as safe as the market was led to
believe, and clearly there's the risk of outflows and wider
front-end credit spreads," said Hans Mikkelsen, credit
strategist at Bank of America Merrill Lynch.
Driving demand has been retail investors pouring into the
front end after being advised that doing so would safeguard them
from losses on longer duration bonds in a rising rate
Corporate cash managers have also been huge buyers of
shorter-dated bonds, having been lulled into a sense of security
by the low volatility at the front end over the past several
years due to the Fed's stimulus program anchoring that part of
the yield curve.
Short-dated bonds will still be in demand, according to
underwriters, but further rate volatility in short-dated
Treasury yields will eventually highlight to the droves of
ultra-conservative investors that have moved into short-dated
bonds that such paper is not risk-free.
"What's made the front end crowded and risky is that the
Fed, through forward guidance, has successfully persuaded
investors that short-term interest rates will be anchored for a
considerable period of time," said Mikkelsen.
"But now the front end may not be as safe as the market was
led to believe, and clearly there's the risk of outflows and
wider front-end credit spreads."
That means less ability to squeeze price on three-year and
"What we tell clients is that there is a risk that the
Treasury yield curve will continue to flatten and if it does
then we could see some of the money that has been piling into
the front end of the credit market move elsewhere," said Andrew
Karp, head of investment grade syndicate for the Americas at
Investors might follow institutional investors and seek out
long-dated paper, but the proliferation of non-traditional and
unconstrained funds in the past six months is a signal that
investors are viewing the bond market as a far more complicated
place than it has been for the past four years.
"Where you put on duration and where you don't is very
specific to names, sectors and asset classes," said Michael
Collins, senior portfolio manager at Prudential, who likes the
back end - where pension funds are buying aggressively.
"Some people find rate risk so difficult to deal with that
they are going into non-traditional unconstrained funds, where
managers hedge out interest rate risk and move up and down the
curve according to relative value, the shape of curves and the
technicals in different markets."
(Reporting by Danielle Robinson; Editing by Matthew Davies)