Long Bond Buyers Get Burned
Trouble brewing at long end of yield curve.
BY Caroline Cakebread | September 14, 2010
Bond Buyers Getting Burned by Going Long as Yields Climb: Credit Markets
(Bloomberg) 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-based 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.
The yield on the 10-year Treasury note has climbed 29 basis points, or 0.29 percentage point, this month to 2.76 percent. 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. General Electric Co.’s finance unit may issue $4 billion of debt in a two-part benchmark sale as soon as today and Symantec Corp. plans its first corporate bond offering ever. Nissan Motor Co. and AmeriCredit Corp. lead companies selling at least $3.6 billion of bonds backed by U.S. consumer debt.
Spreads on company bonds narrowed 4 basis points for the week to 175 basis 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.
GE Capital Notes
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.[bn:WBTKR=GE:US]
GE Capital Corp.’s sale may be made up of three- and 10- year senior unsecured notes, according to a person familiar with the transaction who declined to be identified because terms aren’t set. Benchmark sales are typically at least $500 million.
Symantec, the largest maker of computer security software, may sell as much as $1.1 billion of notes, according to Standard & Poor’s. Proceeds may be used to refinance convertible debt due in 2011, the company said today in a regulatory filing.
Nissan plans to sell $1 billion of bonds backed by auto loans, according to a person familiar with the transaction. AmeriCredit, the lender to auto buyers with poor credit, may issue $700 million of securities backed by car loans.
Credit Swaps Decline
A benchmark indicator of corporate credit risk in the U.S. rose after earlier falling to the lowest since Aug. 4 on increased optimism about global economic growth following a surge in China’s industrial output.
Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 0.4 basis point to a mid-price of 103.2 basis points as of 1:15 a.m. in New York, according to index administrator Markit Group Ltd. The index typically rises as investor confidence deteriorates and declines as it improves.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 0.8 basis point to 104.1, and the Markit iTraxx Crossover Index of credit-default swaps on 50 companies with mostly high-yield credit ratings dropped 9.5 basis points to 465.3, Markit prices show.
Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, and a basis point equals $1,000 annually on a swap protecting $10 million of debt.
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 showed an 8.6 percent chance the Fed will raise its target rate for overnight loans between banks by at least a quarter-percentage point in 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 or 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.