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Good News Spells Bad News for US Bond Market

Wednesday, 29 May 2013 06:48 PM

The spike in Treasury yields hit the US investment-grade bond market on Wednesday, as the sector slid into a loss on the year in the wake of the latest Treasurys sell-off.

Only two new deals came to the high-grade market – and both got a lukewarm reception – after the Barclays Investment Grade Index fell to a negative return of 0.29% for 2013 so far.

High-grade bonds had been red hot of late, but the sell-off in Treasurys – sending yields skyrocketing in the past month – has sent chills through both issuers and investors.

"In the past week the market has changed dramatically," said the manager of investment-grade bond syndicate at one Wall Street bank. "It's night and day."

US investment-grade bond deals had been attracting massive order books from investors, allowing issuers to sell debt cheaply – and pay next to nothing in new-issue concessions.

Through Tuesday, US$102.58 billion in US high-grade bonds priced in May alone, not counting the US$17 billion issue from Apple on April 30, the biggest non-government bond sale ever.

But throughout May, signs have pointed to economic recovery, which prompted comments from Federal Reserve officials about slowing the bank's bond-buying stimulus program.

That in turn has sent investors in safe-haven Treasurys fleeing for the exits, as they have sold off the bonds, causing their yields, which move opposite to prices, to rise.

Rising yields spell bad news for bonds whose valuations are tied to Treasury rates - and 10-year Treasury yields have jumped around 60 basis points (bp) from 1.61% to a high of 2.23% since May 2. (On Wednesday afternoon they were trading around 2.12%.)

That will mean huge losses on recently issued 10-year bonds, such as the US$5.5 billion 10-year tranche of the recent Apple deal.

On Wednesday that 2.4% 10-year was trading at a discount of 95.5 cents or a spread of Treasuries plus 78bp – from a re-offer price of 99.867 and new issue spread of 75bp.

Apple's 3.85% 30-year was trading at 92.00 cents or 105bp, from a re-offer price of 99.418 and a new issue spread of 100bp.


One fear is that more good economic news will keep pushing Treasury yields wider – a source of volatility that wreaks havoc on the market.

"Some investors who would normally come in and buy corporate bonds at these levels have stepped to the sidelines because they are uncertain as to where rates are going at this point," said Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch.

The Organisation for Economic Cooperation and Development said Wednesday that volatility in the US Treasury market poses a significant threat to the global economy – with corporate bonds and mortgage-backed securities (MBS) likely to be hard hit.

While market participants can weather a slow, steady rise in rates, sudden jumps are a problem – not least because that can cause a broader market panic by retail investors.

"If we have a slow move toward a 2.5% 10-year Treasury yield by the first quarter of next year for instance, then that will be good for both stocks and bond spreads," said Mikkelsen.

"What could speed up that move is if we see the 10-year Treasury yield settling into a 2.20%-2.25% range on the back of good economic data this week and next," he said.

The next round of US employment data, a typical measure of the health of the economy, will be released next week.


Investors are not the only ones facing headwinds from the uncertain rates environment - corporate issuers of debt will also be less willing to come to market.

Bond underwriters are already having to manage the expectations of what investment-grade companies can achieve in the market in these conditions.

Just a week ago, issuers with credit ratings of Single A and higher could expect tight pricing – that is, low coupon or interest rates on the debt – as well as a solid performance of their bonds in the secondary market.

But those issuers now will likely have to pay more in new-issue concessions – essentially the extra amount that issuers need to offer to get investors to buy the new debt instead of buying existing bonds in the secondary market.

"New issue concessions will likely be elevated in the near term," said Peter Aherne, head of North America capital markets, syndicate and new products at Citigroup.

"We are encouraging issuers to embed a higher degree of flexibility in their pricing expectations for their deals," he said.

Only two investment-grade issuers came to market on Wednesday: General Electric Capital Corp and Alexandria Real Estate Equities, a real-estate investment trust or REIT.

Neither was able to tighten in pricing from initial guidance or draw significant order books, market sources said.

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The spike in Treasury yields hit the US investment-grade bond market on Wednesday, as the sector slid into a loss on the year in the wake of the latest Treasurys sell-off.
Wednesday, 29 May 2013 06:48 PM
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