Bernanke breathes life into fixed income, but will the market shut down?

Bernanke’s Humphrey Hawkins testimony on Capitol Hill last week sent Treasuries (TIPS) soaring as tapering concerns settled

New issue volume is a very important element of the fixed-income capital markets. The investment grade instruments below in the United States are priced relative to each other, and to a lesser degree as a spread to Treasuries (TIPS).

US High Yield Bond Market Issuance 2013-07-23Enlarge Graph
When new volume comes into a bullish market, it generally prices below comparable existing issuances since investors are competing to get their hands on the new paper. Once the issue prices, it sets the new relative price and similar existing issuance are therefore repriced.

Volumes up

The high yield market (HYG) priced 12 issues last week, for a total of $6.4 billion. This is the largest value since the $6 billion two weeks after the Valeant Pharmaceutical deal pushed volumes up. Given the factors above, we expect there’s a two-to-three-week window for strong new issues, after which the market will slow down considerably for the August vacation period. Weakness from tapering expectations will compound this low issuance and will likely drive bond (JNK) prices lower.

August is upon us and September is around the corner

The recent bounce in fixed-income markets is likely to be short-lived for two reasons.

  1. August is almost here, and August is generally a quiet month in capital markets
  2. September is when tapering is most likely to begin.

August is usually the slowest month of the year in terms of capital market activity in general. The summer vacation of deal makers is by far the main driver of this lull. According to a recent survey by ISI Group (a leading independent broker dealer and macroeconomic research firm), 40% of the surveyed buyside firms expect tapering to begin in September. For this reason, analysts expect that by September, the markets will be close to fully pricing in a reduction of approximately 20% to 25% of the Fed’s $85 billion in monthly bond purchases.