Bernanke Breathes New Life Into Junk-Bond Rally

Thursday, 04 Nov 2010 07:00 AM

 

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The Federal Reserve sent the cost of protecting high-yield, high-risk debt from default to the lowest in almost six months by bolstering demand for the investments with its program to buy $600 billion more of Treasuries.

The benchmark credit-default swaps index for junk bonds that rises as investor confidence improves jumped to the highest since April 15, according to data provider CMA. The extra yield investors demand to own the bonds rather than Treasuries fell 2 basis points to 592 basis points, or 5.92 percentage points, Bank of America Merrill Lynch index data show.

While longer-dated government bonds tumbled, corporate debt from the riskiest borrowers breathed new life into a five-month junk rally that stalled in the past two weeks. The central bank’s move to reduce unemployment and avert deflation by keeping interest rates at record lows is driving yield-starved investors to the least creditworthy borrowers.

“This is a continuation of lower for longer,” said Tom Murphy, a money manager who helps oversee more than $22 billion of investment-grade credit at Columbia Management in Minneapolis. “The response to that from most people is pushing out the risk spectrum.”

The cost of protecting debt from First Data Corp. to iStar Financial Inc. fell as the Fed said new purchases will be about $75 billion a month. Chairman Ben S. Bernanke is trying to boost growth after near-zero interest rates and $1.7 trillion in securities purchases helped pull the economy out of recession without bringing down joblessness close to a 26-year high.

Extended Stay

The Markit CDX North America High Yield Index jumped 0.43 percentage point to 101.1 percent of face value, the highest since April 15, according to data provider CMA. That means the annual cost to protect against a default by the 100 companies in the index fell 10 basis points to 474.3 basis points.

Elsewhere in credit markets, JPMorgan Chase & Co. and Deutsche Bank AG sold $2 billion of commercial-mortgage backed securities tied to hotel properties of Extended Stay Inc. Yield guidance was set on a two-part dollar-denominated bond offering from China’s Sinochem Corp. Prices on leveraged loans rose for a 10th trading day, the longest streak in six weeks.

The largest slice of the offering of mortgage-backed securities from Extended Stay, a $1.2 billion top-rated portion maturing in 4.71 years, yields 165 basis points more than the benchmark swap rate, according to a person familiar with the transaction who declined to be identified because terms aren’t public. The Spartanburg, South Carolina-based hotel operator exited Chapter 11 bankruptcy on Oct. 8.

Sinochem Spreads

Sinochem plans to sell 10-year notes that yield 212.5 basis points to 225 basis points more than similar-maturity U.S. Treasuries and 30-year bonds that pay a 240 basis-point spread, according to a person familiar with the offering. The debt may be issued as soon as tomorrow, the person said.

The Standard & Poor’s/LSTA US Leveraged Loan 100 Index gained 0.12 cent to 91.65 cents on the dollar, the highest since May 6. The index, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has climbed every day since falling to 91.03 cents on Oct. 20. That’s the longest streak since it rose for 11 straight trading days ended Sept. 22.

Bonds from Fairfield, Connecticut-based General Electric Co. were the most actively traded U.S. corporate securities by dealers, with 118 trades of $1 million or more, according to Trace, the bond-pricing service of the Financial Industry Regulatory Authority.

Rally Revives

Relative yields on speculative-grade bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P, declined to as low as 573 basis points on Oct. 27 from this year’s high of 727 basis points on June 11, Bank of America Merrill Lynch index data show. Spreads climbed to 596 basis points as of Nov. 1 as the high-yield rally stalled.

After the U.S. central bank announced its bond purchase plan, relative yields declined. The Fed’s Open Market Committee said it “will adjust the program as needed to best foster maximum employment and price stability.” Policy makers also retained a pledge to keep interest rates low for an “extended period.”

At 9.6 percent, the unemployment rate “is elevated, and measures of underlying inflation are somewhat low, relative to levels that the committee judges to be consistent, over the longer run, with its dual mandate,” the Fed said. “Progress toward its objectives has been disappointingly slow.”

‘Underlying Problems’

While the Fed’s stimulus measures may contain the risk of deflation and trim interest costs, they won’t meaningfully reduce the challenge facing U.S. companies of excessive debt, said Marvin Barth, chief investment strategist at Santa Monica, California-based Tennenbaum Capital Partners LLC.

“This doesn’t address the underlying problems,” Barth said today in a Bloomberg Television interview in New York before the Fed announcement. “You still have the fact that top- line growth is going to be poor because the economic outlook is going to be poor because we’re recovering from a significant overleveraging of our society.”

U.S. real gross domestic product, adjusted for inflation, grew at a 2 percent annual pace in the third quarter, faster than the 1.7 percent rate between April and June yet still below what central bank officials believe is needed to reduce unemployment. Economists in a Bloomberg News survey last month forecast the unemployment rate will average 9.3 percent next year.

Retail Sales Rise

The economy has shown some signs of strength. Retail sales increased more than forecast in September, and manufacturing expanded in October at the fastest pace in five months. The ISM non-manufacturing employment gauge rose to 50.9 in October, matching the July level that was the highest since the recession started in December 2007. The measure of new orders increased to a three-month high.

First Data’s $3.7 billion of 10.55 percent notes due in September 2015 rose 1.8 cents to 87.06 cents on the dollar, Trace data show. That’s the highest price for the Atlanta-based credit-card processor’s bonds since May.

IStar’s $111.8 million of 5.5 percent bonds due June 2012 climbed 1.5 cents to 90 cents on the dollar, the highest since May 2008, Trace data show. The bonds from the New York-based commercial real estate lender have risen from 31.5 cents in March 2009.

Investment Grade

The cost of protecting investment-grade corporate bonds from losses also declined. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decreased 1.25 basis points to a mid-price of 91.25 as of 8 p.m. in New York, according to index administrator Markit Group Ltd.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

While corporate debt rallied, Treasury 30-year bonds fell the most in two months. Thirty-year bond yields rose 11 basis points to yield 4.04 percent at 5:07 p.m. in New York, after earlier reaching the biggest rise since Sept. 9. The 3.875 percent bonds due in August 2040 rose 1 30/32, or $19.38 per $1,000, to 97 4/32. The two-year note yield fell 2 basis points to 0.33 percent, near the record low 0.3270 percent on Oct. 12.

The Fed program “helps mitigate the downside risk to economic growth and it also keep rates low, and both those things help push investors down the quality spectrum,” said Adam Richmond, a strategist at Morgan Stanley in New York.

© Copyright 2014 Bloomberg News. All rights reserved.

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