30 Jul

Why high-grade and high-yield markets assess risks before FOMC

WRITTEN BY Phalguni Soni

High-grade issuance surges while junk debt volumes fall

Corporate borrowers in the high-grade (LQD) and leveraged loans segment stepped up primary market issuance in the week ending July 25. Investment-grade (AGG) borrowers issued debt worth $21.7 billion—up by over 50% from the previous week. However, high-yield (HYG) or junk-rated issuance volumes decreased by ~33% last week and came in at $4.56 billion. Leveraged loans issuance showed the greatest surge, increasing by 140% week-over-week (or WoW) to $10.7 billion (Data source: Investment-grade issuance—Bloomberg, high-yield and leveraged loans—S&P Capital IQ/LCD).

Why high-grade and high-yield markets assess risks before FOMC

Impact of earnings blackouts

Issuance in the investment-grade bonds market had been low the previous week. Due to the onset of the earnings season, a number of firms were subject to earnings blackouts. Mid-way through the reporting season, we are seeing corporate issuers return to the debt markets, including S&P 500 Index (VOO) component companies Broadcom (BRCM), eBay, Citigroup, and Wells Fargo. There also appears to be greater investor appetite for investment-grade issues compared to lower-rated issues.

Impact of credit and geopolitical risks

In contrast, high-yield bond issuance was affected by adverse market sentiment. Geopolitical and credit risk factors were largely responsible for putting a dampener on issuance volumes. Unrest in the Middle East—Gaza and Iraq—along with the political ramifications of the MH17 plane crash over Ukraine were some of the overseas events that affected risk perceptions.

Yields for junk-rated debt had also fallen to record lows on June 23. This factor, along with fears of stretched valuations in this asset class, contributed to the adverse market sentiment. They were instrumental in keeping issuers away. Issuers also appeared to be less confident in the market environment compared to previous weeks.

You’ll find an analysis of the surge in leveraged loans in Part 8 of this series.

Secondary market flows

Investor flows into mutual funds for various assets are key momentum indicators for the asset class. Although they typically lag market sentiment, they provide valuable clues for gauging investor behavior.

Last week, investment-grade bond mutual funds recorded net inflows of ~$1.6 billion, compared to net outflows of ~$2.4 billion for high-yield debt mutual funds (Source: Lipper). During times of heightened risk, investors typically show preference for safer assets like U.S. Treasuries and investment-grade debt.

Impact of this week’s FOMC meeting

Markets don’t really expect any change in the Fed’s policy in reinvesting proceeds of maturing Treasury and agency-backed securities. The Fed is also expected to reiterate its dovish stance of keeping the Fed funds rate low until at least 1Q15. These factors will likely to have a downward effect on the longer-end of the Treasury yield curve.

Market anticipation of these factors were probably the reason yields on investment-grade debt didn’t increase over the week, despite positive economic data. Initial jobless claims dropped unexpectedly to 284,000—the lowest in over eight years—according to the report released last Thursday. Manufacturing releases last week were also mostly positive.

Generally, bond yields increase when the economy is expanding because the central bank will likely raise rates sooner rather than later. The demand for financing for funding new projects also increases which generally tends to increase rates. However, anticipation of the Fed’s continued accommodative policy at the end of the July Federal Open Market Committee (or FOMC), was a major factor preventing yields from going northwards.

Primary and secondary markets update for corporate debt

In this series, you’ll find an update on the key primary and secondary market trends in high-grade debt (Parts 2–4), high-yield debt (Parts 5–7), and leveraged loans (Parts 8–9).

A number of S&P 500 Index companies were major debt issuers last week, including eBay, Citigroup, Broadcom, and ConAgra Foods. Please continue reading the next section in this series.

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