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Back to business in the bond market

August 19, 2020

Investing-grade and high-yield bond interest rates, 2010 o July 2020 chart
The March disruption in the capital markets was particularly evident in the bond market, as a “flight to liquidity” drove investors out of risk assets into cash. The Federal Reserve noted the broken “plumbing” of the fixed income market and pledged unprecedented support through direct bond purchases and several aggressive liquidity programs. These announcements rapidly steadied the market, bringing yield spreads on investment-grade and high-yield indexes to below historic averages.

The combination of Fed assertiveness and plunging Treasury yields have dropped borrowing costs to record lows, despite rising delinquencies and stressed corporate balance sheets. The borrowing cost for the average investment-grade borrower is just over 1% today, versus 1.6% in March and 3.6% in late 2018. High-yield rates average roughly 6% right now, compared with 9.3% in March and 8.0% in late 2018. (See Chart 1 above.) While the Fed has slowed its asset purchases, there’s no indication this is impacting demand.

The advantage for corporate borrowers can be seen not only in lower costs, but also in higher issuance. High-yield issuance was essentially shut down in March, but that window has opened materially since then; high-yield bond issuance is on pace to reach $385 billion in 2020, eclipsing the previous record of $332 billion in 2013. Investment-grade issuance never really slowed, with $264 billion of new bond issues in March alone. Investment-grade issuance could potentially reach $2.2 trillion in 2020, nearly double the level of 2019. (See Chart 2 below.)

Investment-grade and high-yield bond issuance, 2010 to 2020 estimated

While the apparent disconnect between fundamental uncertainty and an accommodative market is good for borrowers, it puts pressure on investors to assume greater risk, as investment-grade funds now have a negative yield when adjusted for inflation. Additionally, the low yields on corporate bonds decrease the opportunity cost to invest elsewhere, likely driving investor appetite for stocks and gold.

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    Past performance does not guarantee future results. Current performance may be lower or higher than the past performance shown.

    Bloomberg Barclays US Aggregate Bond Index: An unmanaged, market value-weighted index of U.S. dollar-denominated, investment-grade, fixed-rate, taxable debt issues, which includes Treasuries, government-related and corporate securities, mortgage- backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), asset-backed securities and commercial mortgage-backed securities (agency and non-agency).

    ICE BofA Merrill Lynch (BofAML) U.S. High Yield Index: An unmanaged, market capitalization-weighted index that gives a broad-based

    measurement of U.S. high-yield fixed-income markets; measures the performance of below-investment-grade, corporate debt with a minimum of 18 months remaining to final maturity at issuance that is publicly issued in major domestic markets.

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