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High-Grade Bonds Enter a Summer of Discontent

  • Record Pace
    Top-rated companies have been selling bonds at a record pace this year in the U.S.

    Source: Bloomberg

    Funds that focus on the debt have received $153 billion this year, surpassing the amount of flows for all of last year and just $10 billion shy of the annual record inflow in 2012, according to Wells Fargo Securities credit strategist George Bory.

  • Shrinking Cushion
    Buyers are earning the least extra yield over benchmarks on high-grade debt since 2014

    Source: Bloomberg Barclays indexes

    Now, however, demand is starting to slow, with mutual funds receiving their smallest inflow last week in five months, Bory noted.

  • Big Flows
    This year has broken records with respect to U.S. investment-grade bond flows

    Source: Bloomberg

    First, while it’s a bit of a stretch to say inflation is accelerating globally, at least investors don’t seem overly worried about deflation.

  • Yields around the world are already moving up, albeit slowly, making the U.S. less attractive on a relative basis.Second, investment-grade bonds have become more sensitive to moves in interest rates because of their low cushions of extra yields and lengthening maturities.
  • For example, U.S. high-grade notes won’t come due for about 10.5 years on average, about a year longer than the average in 2013, according to Bank of America Merrill Lynch index data.This doesn’t mean that there’ll necessarily be a huge selloff in the U.S. investment-grade bond market soon.

It looks as if the $5.8 trillion market has moved past its peak.

@lisaabramowicz1: US investment-grade bond funds have received $153 billion this year, surpassing the amount of flows for all of 2016.

Apparently every investor on Earth got a memo to buy U.S. investment-grade corporate bonds this year.

Funds that focus on the debt have received $153 billion this year, surpassing the amount of flows for all of last year and just $10 billion shy of the annual record inflow in 2012, according to Wells Fargo Securities credit strategist George Bory. Top-rated corporations are selling an unprecedented amount of bonds. Investors are accepting the lowest premiums over benchmark rates to own the debt in almost three years.

Now, however, demand is starting to slow, with mutual funds receiving their smallest inflow last week in five months, Bory noted. It’s quite likely that this $5.8 trillion market has moved past its peak and that investment-grade debt won’t be as attractive the rest of the year.

First, while it’s a bit of a stretch to say inflation is accelerating globally, at least investors don’t seem overly worried about deflation. That makes it hard to see how global benchmark bond yields will plummet from already ultra-low levels, especially amid speculation that European central banks will start reducing stimulus. Yields around the world are already moving up, albeit slowly, making the U.S. less attractive on a relative basis.

Second, investment-grade bonds have become more sensitive to moves in interest rates because of their low cushions of extra yields and lengthening maturities. For example, U.S. high-grade notes won’t come due for about 10.5 years on average, about a year longer than the average in 2013, according to Bank of America Merrill Lynch index data.

This doesn’t mean that there’ll necessarily be a huge selloff in the U.S. investment-grade bond market soon. For that to happen, there would need to be an unexpected downgrade of a big company or two, which would be unexpected at a time of steady (albeit slow) growth. Or there would need to be a material repricing of U.S. Treasuries, which seems unlikely given the unwillingness on the part of central bankers to upend the status quo.

But top-rated corporate notes are increasingly used as a proxy for government debt. Their cushions of extra yield have eroded, making them more vulnerable to fluctuations in benchmark rates. It’s easy to see how the last six months of the year will be tougher going that the first six.

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High-Grade Bonds Enter a Summer of Discontent