Investors who snapped up the biggest supply of long-maturity bonds since March last month are being punished as interest rates climb on diminished concerns the U.S. will relapse into recession.
Corporate bonds due in 15 years or more have lost 3.15 percent since Aug. 31 while notes maturing in 1 to 10 years lost 0.67 percent, Bank of America Merrill Lynch index data show. In the three months ended in August, the longer-maturity bonds had gained 11 percent, more than double the 5 percent gain for shorter-dated securities, as record-low yields sent investors searching for higher-paying fixed-income securities.
The losses underscore the extra risk in the longest-maturity bonds if the economy recovers faster than investors expect, causing interest rates to jump and eroding the value of the debt. The duration of company bonds, a measure of the securities’ price sensitivity to yield changes, reached a record at the end of August, according to Bank of America Merrill Lynch’s U.S. Corporate Master index.
“Now is not the time to reach for yield by extending out on the yield curve,” said James Barnes, a fixed-income portfolio manager at Wyomissing, Pennsylvania National Penn Investors Trust Co. “If we grow very sluggishly, it still bodes well for interest rates going higher.”
Companies taking advantage of lower yields last month sold $14.4 billion of U.S. dollar-denominated debt maturing in more than 15 years, according to data compiled by Bloomberg. That’s the biggest sum since March, when $15.6 billion of the bonds were sold.
Rising Treasury Yields
The yield on the 10-year Treasury note has climbed 32 basis points, or 0.32 percentage point, this month to 2.79 percent as of Sept. 10. The yield had dropped to the lowest since January 2009 after the Federal Reserve said some policy makers saw greater risks to the economic recovery and that it would maintain holdings of securities to prevent money from being drained out of the financial system it helped prop up after the credit seizure two years ago.
Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds rather than government securities fell to the lowest in a month. Hewlett-Packard Co. and Home Depot Inc. led $105.9 billion of bond sales worldwide last week, more than double the pace of the period ended Sept. 3. The cost of protecting corporate debt from default in the U.S. fell for a second week, benchmark indexes of credit-default swaps show. Leveraged loan prices rose to the highest since Aug. 11.
Spreads on company bonds narrowed 4 basis points for the week to 175 basis points, or 1.75 percentage points, the lowest since Aug. 10, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. Average yields climbed to 3.637 percent, compared with 3.595 percent on Sept. 3.
Hewlett-Packard, the world’s largest personal-computer maker, and Atlanta-based Home Depot led the surge of offerings as companies sought to take advantage of U.S. investment-grade borrowing costs near the lowest on record.
Palo Alto, California-based Hewlett-Packard’s $3 billion offering consisted of $800 million of 2-year floating-rate securities and $1.1 billion each of 3- and 5-year debt, Bloomberg data show. Home Depot, the largest-home improvement retailer, sold $1 billion of debt split evenly between 10- and 30-year maturities in its first offering since December 2006.
Yields as of the end of last week were at 3.958 percent, after reaching as low as 3.743 percent on Aug. 24, the lowest in the measure’s history dating to October 1986, according to the Bank of America Merrill Lynch U.S. Corporate Master index.
Credit Swaps Decline
The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell 1 basis point last week to 102.92 basis points, the lowest since Aug. 9, according to prices from Markit Group Ltd. In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 0.03 basis point to 105.87, Markit prices show.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default 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.
The Standard & Poor’s/LSTA US Leveraged Loan 100 Index rose 0.1 cent for the week to 89.67 cents on the dollar. The index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, returned 4.62 percent this year.
Duration Measure Falling
In emerging markets, relative yields rose 2 basis points for the week to 277 basis points, according to JPMorgan Chase & Co. index data. Spreads soared as high as 289 basis points on Sept. 7 before declining in each of the next three days.
The duration of U.S. investment-grade corporate bonds reached 6.56 years on Aug. 31, the highest since at least 1996, Bank of America Merrill Lynch index data show. The measure, which began the year at 6.2 years, has since fallen back to 6.43.
“I would not be applying fresh capital to the long end of the yield curve,” said Chad Morganlander, a money manager at Stifel Nicolaus & Co., which oversees $90 billion. “Any sign of economic vitality, without government assistance, would be deleterious.” Morganlander, who’s based in Florham Park, New Jersey, said he’s buying investment-grade securities that mature in five years or less.
Yields on 10-year Treasury notes reached a one-month high on Sept. 10 on evidence the world’s largest economy isn’t falling into another recession.
Benchmark debt yields had a third week of gains in the longest stretch of advances since October. The Commerce Department reported Sept. 10 that inventories at U.S. wholesalers rose in July by the most in two years on a rebound in demand. A 1.3 percent increase in the value of inventories was three times the median estimate in a Bloomberg News survey of 32 economists.
Futures show a 9.5 percent chance the Fed will raise its target rate for overnight loans between banks by at least a quarter-percentage point by March, up from 7.5 percent a week ago. The central bank has left the rate unchanged in a range of zero to 0.25 percent since December 2008.
Bonds due in 15 years of more from Juno Beach, Florida- based NextEra Energy Inc., the largest U.S. producer of renewable energy, have lost 4.28 percent on average this month, Bank of America Merrill Lynch index data show. Longer-dated bonds of drugmaker Abbott Laboratories of Abbott Park, Illinois, declined 4.43 percent, while debt from Armonk, New York-based computer-services provider International Business Machines Corp. fell 4.08 percent.
IBM Bonds Fall
IBM’s $1.52 billion of 5.6 percent bonds due in 2039 have dropped 5.9 cents to 112.1 cents on the dollar since Aug. 25, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield rose to 4.82 percent from 4.49 percent.
Investors should seek corporate bonds that pack a bigger cushion against spikes in interest rates, including the highest- rated high-yield, high-risk bonds, according to strategists at Goldman Sachs Group Inc.
Speculative-grade or junk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P, typically offer yields that compensate investors more for the risk that the company defaults. As a result, the bonds may gain more from declining default risk than they lose from rising interest rates, said Alberto Gallo, a New York-based strategist at Goldman Sachs.
“If rates rise, investment-grade will be more penalized because of its higher duration and because rates are a higher percentage of total yield,” Gallo said in an interview. “If the economy grows, spreads can compress and absorb the rise in rates. However, spreads are a smaller percentage of the yield in investment-grade than they are in high yield.”
Fixed-income investors also may hedge against rises in interest rates with derivatives contracts.
U.S. corporate bonds in the BB rated tier, the highest in speculative grade, yield 468 basis points more than similar- maturity Treasuries, Bank of America Merrill Lynch index data show. The spread is almost double the 239 basis points offered by BBB tier bonds, the lowest investment-grade ratings. The average spread on all investment-grade bonds is 187 basis points.
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