Why the investment-grade bond market declined last week


Oct. 29 2019, Updated 6:59 p.m. ET

A decline

After weeks of good earnings releases that largely supported the U.S. equity market (SPY) and the investment-grade corporate bond market, last week’s activity recoiled dramatically. Despite lower borrowing costs and yields, the primary corporate bond (LQD) market remained dull. Issuance declined substantially, by 33% to $33.7 billion from $50.0 billion the previous week. A total number of 26 issuers accessed the market, with an average ticket size of $1.30 billion—slightly lower than the average ticket size of over $1.35 billion in the previous week, when 37 issuers came to market.

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Investment-grade bonds are debt securities issued with a credit rating of BBB- or above. These bonds are considered the next safe haven after U.S. government bonds, which are mostly rated AA+ or above. The average yield on the Bank of America Merrill Lynch U.S. Corporate Master index declined to 3.12% last week, which is the lowest since September 2013. Investment-grade corporate bonds pay either fixed-term or floating interest rates that reference a benchmark such as LIBOR[1. LIBOR stands for the “London Interbank Offered Rate” and it’s the benchmark interest rate for many adjustable-rate mortgages, business loans, and financial instruments traded on global financial markets. Currently, the three-month LIBOR rate is 0.24%].

FRN (floating rate note) debt securities adjust their interest rate with changes in the prevailing market interest rates, unlike fixed-interest-rate bonds such as the SPDR Barclays Capital High Yield Bond ETF (JNK). The credit spread on the Bank of America Merrill Lynch U.S. Corporate Master index ended last week at 1.25%, which was 4 basis point lower than the previous week. The credit spread is the risk premium paid over the U.S. Treasuries to compensate for the additional credit risk borne by investors while investing in other bonds.

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Activities in the corporate bond market highly correlate with issuers’ earnings. A higher earnings release improves the outlook on the U.S. equity market (SPY) with a rise in corporate fundamentals. However, the same outlook is bad for the bond market as investors flee to invest in the equity market, thereby reducing liquidity in the bond market. When liquidity drops, the cost of issuing a bond becomes expensive.

Last week, two retailers released their quarter or fiscal year earnings data, including Urban Outfitters, Inc. (URBN) and Dollar General Oration (DG). Urban Outfitters, Inc. (URBN), a leading American retail company, posted lower-than expected quarterly sales last week. The company said that a decline in sales figures and earnings was impacted by severe weather conditions. The Dollar General Corporation, a discount retailer in the U.S., posted a 6.8% increase in quarterly sales, meeting Wall Street analysts’ expectations.


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