Investors are hungry for yield, yet new issuance in credit sectors is declining -- a combination that's supportive for bonds long-term.
While U.S. bonds have benefited from the flight to safety driven by worries about the COVID-19 virus, the market is also seeing support from a growing mismatch of supply and demand.
Issuance of investment-grade corporate bonds by U.S. firms has been falling since early 2016; high-yield issuance began declining even earlier, in 2015. Bank loans, after a pickup, have fallen since mid-2018. Yet demand has been rising, as investors and institutions continue their increasingly-difficult search for yield to meet pension obligations and other forms of income in the face of the aging of populations worldwide.
This, of course, represents a tailwind for bond prices that applies broadly both to the investment-grade and high-yield sectors, notwithstanding weakness in certain sectors (such as energy) driven by industry-specific concerns.
Net New Issuance by Sector
Chart courtesy of Western Asset. Source: J.P. Morgan, Western Asset, as of 31 Dec 2019 Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
That’s a key reason Western Asset posits that the anticipated gross $1 trillion in anticipated supply from the world’s central banks and corporates will be absorbed even more strongly than in 2019, itself a record year for returns in IG credit.
The same could also hold true in the smaller high-yield (HY) sector, where Western Asset anticipates that the excess of demand over supply of about $100 billion in 2019 will continue to grow in 2020 – which should help the sector recover from its current fear-driven slump this year.
On the rise: “Safe Haven” assets
Pandemic fears drove down investors’ risk appetite last week, impacting both bond and currency prices. The Swiss franc, Japanese yen and euro appreciated the most against the U.S. dollar over the past five days,1 up 0.89%, 0.85% and 0.68% respectively. Among ten-year sovereign issues, yields rose the most for Greece, Italy and Spain, up 8.9, 3.9 and 2.7 percentage points.
In terms of spreads, Brazil and Mexico widened by 10.3 and 9.0 bps vs. the 10-year Treasury to 171 and 143 bps. In Europe, Greece and Italy widened by 17.5 and 9.9 bps to 163 and 152 bps against benchmark Bunds, whose yield reached a year-to-date low of about -0.53% at 4:12 AM ET on February 26.
In Emerging Market (EM) US dollar 10-year bonds, Turkey and Chile saw spreads widen by 22 and 14 bps respectively due to country-specific factors; for local-currency EM issues, spreads widened the most for Lebanon, Taiwan and Turkey (170, 135 and 38 bps). Of the three, country-specific concerns having little to do with the coronavirus were clearly key; the only obvious direct link to the spread of the coronavirus was to be found in Taiwan.
On the slide: U.S. Treasury yields
Ten-year Treasury yields reached an all-time low of 1.3055% on February 25, at 2:09 PM ET. At the same exact time, the 30-year reached the all-time low of 1.78%.Other moves drove the 3 month/30-year yield curve solidly into inverted territory, at -16.8 bps – a new low for the year, but still well above the -51 bps inversion of August 27, 2019. That said, the uncertainties surrounding the impact of the coronavirus on both fundamentals and sentiment all but guarantee that more records of this sort could be broken in the days, weeks and months to come.
Note: The year for all dates is 2020 unless otherwise indicated.
1 All prices and related data in this article are Source: Bloomberg, Feb 26, 2020, 5:45 AM ET.
A safe haven is an investment that is hoped to retain or increase in value during times of market turbulence. Safe havens are sought by investors to limit their exposure to losses in the event of market downturns.
“Bunds” refers to bonds issued by Germany's federal government. Bunds are available in 10- and 30-year maturities.
COVID-19 is the World Health Organization's official designation of the current coronavirus.
In finance and investing, tailwind describes some condition or situation that will help a trend in growth or value continue more strongly.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
A spread is the difference in yield between two different types of fixed income securities with similar maturities.
A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
Investment-grade (IG) bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.
The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.
Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.