Record-low interest rates at the end of August and an increase in sales of fresh debt in September created a boom in low-yield bonds. Companies sold a record US$74 billion of investment-grade bonds in the first week of September – a Niagara of debt surpassing any other week since such record-keeping began in 1972, according to Bloomberg LP. Companies rushed to get in on the massive bond financing discount.
The borrowers were marquee names: Coca-Cola Co. and Apple Inc. The average yield on the week’s drop was 2.77%, down from 4.3% in November 2018. That saved borrowers US$153 million per US$1 billion of debt.
With interest rates low in Europe, Siemens AG, a Germany-based electrical equipment manufacturer, sold negative-pay bonds in August. In the U.S., Deere & Co. sold 30-year bonds at 2.87%, an historical low for the company. The U.S. has become a discount store for debt. This debt sells in the global market, where key rates for 10-year sovereign debt are 0.631 for British gilts and -0.554 for bunds. The highest rate in the European wing of the Organization for Economic Co-operation and Development is found in Greece, the 10-year bonds of which pay 1.515%.
Corporate debt priced off these levels pays better than government debt, but the winners are the borrowers.
Canadian issuance has moved in lockstep with U.S. new issues. Canada’s new corporate issues are projected to reach $14 billion for September, says Patrick O’Toole, vice president, global fixed-income, with CIBC Asset Management Inc. in Toronto, compared with $8 billion for September 2018.
The surge is seasonal; corporate bond issuance in Canada is $74 billion for the year to mid-September, compared with $84 billion over the same period last year, he adds.
Behind the surge in bond sales is a global rush for yield. Negative nominal rates in Europe have propelled buyers into North American markets, where base government bond rates are positive and unlikely to acquire minus signs. But global bond buyers want debt with some positive payback. Not surprising, even junk bonds with nominally good returns promised, compared with negative-pay higher-grade bonds, are doing well. Junk that pays more junk, called pay-in-kind (PIK) bonds, are selling well. PIKs were used by Robert Campeau in his takeover of retail giants in the U.S. including Allied Stores Corp. and Federated Department Stores Inc. – all of which went into bankruptcy – in the 1980s. The new PIKs have 12% coupons, O’Toole says. That’s a fine return compared with those offered by the low single-digit sovereigns and senior corporates – assuming someone will buy your PIKs or that you’ll be repaid by the issuer.
How much longer this bond rush will continue is the question, both for potential issuers adding to the supply of global bonds and for buyers who want to get the best returns they can.
There have been other bond bull runs in the past during which prices rose seemingly without limit. The bond price surge that began after Paul Volcker at the U.S. Federal Reserve Board and Gerald Bouey at the Bank of Canada broke the back of inflation in the early 1980s has continued with only brief interruptions, making it the longest bull run since rates in the U.K. fell after the Napoleonic Wars and, before that, when Italian Renaissance banking innovations made trading in debt instruments more secure, thereby reducing risk. A trip through banking history makes the point stressed by a Financial Times story published on Sept. 9, 2019, when the supply of money and credit rises and risk declines, the price of money – that is, interest – also falls.
Central banks in Europe and Japan have set the stage for issuing more bonds at negative rates. Moreover, O’Toole says, the vast amounts of credit that have pumped up the banking system have created a great deal of money looking for a home. There is little chance of rates returning to 5% for 10-year U.S. treasuries, which remain the foundation for much of the world’s debt markets.
“The supply of corporate bonds has been easily absorbed by investors,” says Chris Kresic, head of fixed-income and asset allocation with Jarislowsky Fraser Ltd. in Toronto.
Adds O’Toole: “Investors are desperate for yield.”
Business conditions remain fairly good. The Merrill Lynch master II high yield index remains low. Recently, it hovered at 389, which is near the low end of its historical range of 200 to 2,000. U.S. treasury 10-year rates have been at 1.50% and Government of Canada 10-year bonds at 1.15%, a boost to 2.23% for BB-rated and 4.24% for B-rated bonds.
That’s the market for debt now. Low prevailing rates for bellwether government debt have set a ceiling for rates for both investment-grade and sub-investment grade corporates. Companies are getting money cheaply, and investors are buying corporates to get a boost over low and sometimes negative rates on government debt.
If there is a recession in the U.S. and Canada, companies will find paying low-yield bonds easy while investors will have security blankets reducing equities’ risk. You could say that what investors do not get in yield from low-payout debt is the price of security.
That seems to be the rationale for the trade in debt at record-low rates that may not even cover the cost of inflation.