In the midst of the worst market sell-off in a decade, as the spread of coronavirus sent asset prices tumbling, capital markets shut down.
Just as they needed it most, companies were locked out of a crucial source of funding to see them through the ensuing crisis.
Then, on March 23, the Federal Reserve stepped in to try and ease market functioning, taking the historic step of announcing that the central bank would begin purchasing corporate bonds. The response from investors was rapid; bond prices began rebounding, capital markets opened and a flood of new bonds were sold as companies rushed to secure emergency funds.
The intervention helped to bring down corporate borrowing costs, which had spiralled to a 10-year high for investment grade companies during the coronavirus-induced sell-off in March.
This led to the fastest pace of fundraising on record, with the total number of US corporate bonds sold so far this year topping $2tn, an annual threshold that had previously never been breached — and there is still a full quarter of the year left.
So where now for corporations and investors ? “All issuers were, and some still are, fighting for their life,” says Robert Tipp, chief investment strategist at PGIM Fixed Income. “It really behoves corporate managers to go and borrow to make sure they survive. If things turn out to be better than expected or there are just other opportunities out there for strategic acquisitions, having that money is going to be easy for them to justify.”
What began as a dash for cash from companies looking to plug the hole in their revenues ravaged by coronavirus, has turned into an opportunistic bond binge, with companies taking advantage of rampant investor demand to borrow money at historically low interest rates.
In June, Amazon locked in record low borrowing costs as it raised $10bn across different maturities. Its 10-year note pays investors a coupon of just 1.5 per cent, less than a percentage point more than the cost of borrowing for the US, government at the time, then setting an all-time low in the US corporate bond market.
Just two months later, Google’s parent Alphabet sold a 10-year bond with a coupon of 1.1 per cent, breaking the record again. It marked an unusual appearance in the market for a company flush with cash that hadn’t sold a bond since 2016.
Overall, the yield on blue-chip, investment-grade bonds fell to an all time low of just 1.87 per cent in July. A sharp reversal from a peak of 4.7 per cent reached the day before the Fed intervened — the highest yield in a decade.
“The recovery has obviously been outstanding, almost beyond belief,” says Henry Peabody, a portfolio manager at MFS Investment Management.
Starved of higher returns in safer government bonds after the Fed slashed interest rates to zero early on in the crisis, investors have looked to the corporate bond market as a way to earn a higher yield, pouring more than £100bn into funds that buy US corporate bonds and adding fuel to the ferocious rally.
As yields have also declined on higher rated debt, the reach for yield has extended to lower quality companies, with investors increasingly shrugging off uncertainty over the future of the US economy as they attempt to generate returns.
Aluminium can maker Ball Corporation secured the lowest ever borrowing cost for a junk-rated company in August, according to financial data provider Refinitiv, raising $1.3bn through a 10-year bond at a coupon of just 2.875 per cent.
Overall, the yield across junk bonds has dropped from a peak of 11.4 per cent in March, to just 5.8 per cent, close to a year-to-date low of 5.1 per cent, set in January before the spread of coronavirus sent bond markets into a tailspin.
Peter Tchir, chief macro strategist at Academy Securities says the decline in yields leaves investors in a tricky position. “You either have to plug your nose, dive deep and hope for a recovery,” he said. “Or you remain cautious. But that doesn’t generate returns.”
Others warn that life does not appear to be about to get any easier. A spate of bond sales over the past month is likely to dissipate as the US election draws near, as bankers and investors expect more violent price swings as presidential hopefuls duel.
Without the flood of new supply, investors are left to fight over the bonds already in the market, potentially driving prices higher and yields even lower.
On top of that, there remains a concern over a fresh outbreak of coronavirus, particularly as colder weather sets in, further contributing to uncertainty over the economic outlook. “I think the next few months will be tough,” said Mr Peabody. “None of us know what will happen.”
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