American corporate debt is falling to its lowest level since 2008. What comes next depends on inflation

Stocks and crypto aren’t the only things being slammed.

Billions in bonds from Fortune 500 companies, which are considered almost failsafe, have also been marked in a financial asset yard sale as the Federal Reserve works to raise interest rates and push inflation to the highest level in four decades reduce.

The US investment-grade corporate bond index dollar rate recently fell to $93.5 (see chart), the lowest level since the global financial crisis, according to data from BofA Global.

Investment grade bond prices have fallen to low prices since 2008

ICE Data, BofA Global

A number of highly rated corporate bonds in the index have fallen even further during one of the worst stretches in total return history.

U.S. investment-grade corporate bonds were locked in for a total return of -13.9% this year through Monday, compared with -9.3% for high yield, a decline that said it was one of the worst-performing sectors in the bond space made Mizuho securities.

“There are several quality bonds in the tech space where the long 30-year bonds are trading at 70 to 60 cents on the dollar,” Arvind Narayanan, co-head of investment-grade credit at The Vanguard Group, said on the phone.

“These are names with a high AA rating, almost AAA credit,” he said, noting the rare discounts on such bonds as global central banks pull pandemic support from markets.

“Companies and their debt have to stand on their own two feet,” Narayanan said. “This is a great opportunity for active investors to create real value for clients.”

Tech wreck, in debt

The past two decades have been notorious for falling interest rates, reflected in years when investors flocked to the deep well of the US investment-grade corporate bond market in search of yield.

The high demand meant that much of the debt in the investment-grade corporate bond index typically traded at a premium to face value or above the $100 price that many bonds fetch at issuance.

“Only 15% of the days since 2020 has the average index price fallen below face value,” strategists at BofA Global wrote in a weekly note to clients. “Currently, nearly a third (32%) of the index’s face value is trading below $90 and 9% – below $80. Not surprisingly, 92% of bonds priced below $80 have 10+ years.”

A backdrop of rising interest rates has resulted in drastic stock prices for many of the largest US tech companies including Apple Inc., AAPL,
Netflix Inc. NFLX,
-2.04% AMZN,
and Google GOOG,
parent alphabet.

It has also spurred a red sea for corporate bonds this year, particularly for debt maturing in a decade and beyond, according to Bondcliq data. For example, Apple’s AA+ rated 2.7% coupon bonds maturing in August 2051 traded at around $76 on Wednesday.

interest rate chaos

Historically, when prices for most of the $10 trillion US corporate bond market have collapsed, it could often be attributed to concerns about “credit problems” such as rising corporate defaults.

Bankruptcies were clearly an issue when banks collapsed in 2008, but also initially in 2020 when much of the world instituted lockdown measures to slow the spread of COVID 19. However, many companies have used cheap debt over the past two years to strengthen their balance sheets and further defer funding needs.

“It’s an unusual situation,” said Nick Elfner, co-head of research at Breckinridge Capital Advisors, who said much of the decline in corporate bond prices over the past six months has been rate-driven.

Bonds are priced at a spread or premium over risk-free interest rates. The 10-year Treasury rate TMUBMUSD10Y,
was up nearly 2.95% on Wednesday, up from a yearly low of about 1.63% on Jan. 3, 2022, according to Dow Jones Market Data. When bond yields rise, prices fall.

“In 2009, it was based on credit risk, downgrades and solvency risk in the banking sector,” Elfner said over the phone. “Right now you’re seeing the opposite as upgrades are outpacing downgrades, corporate liquidity is plentiful and interest coverage is high.”

But he also called the sharp rise in interest rates a “double-edged sword” that not only inflicts painful short-term losses on bond investors, but also the opportunity for higher yields later when yields rise.

The return of the ICE BofA US Corporate Index was fixed at 4.4% at the start of the week, iecloser to the 4.7% peak at the beginning of the pandemic in 2020.

As bonds sold off, some of the froth also came from other, more speculative parts of the markets, with Bitcoin BTCUSD,
36% YoY through Wednesday and the tech-heavy Nasdaq Composite Index COMP,
21% discount, according to FactSet.

The big question going forward will be whether the Fed can tame inflation without triggering a recession that would rekindle credit concerns for many corporate bond investors.

Against the backdrop of uncertainty, Vanguard’s Narayanan said investors remained disciplined in how they deployed their capital. However, he also said that this could mean that prices for the flea market have to drop even more. American corporate debt is falling to its lowest level since 2008. What comes next depends on inflation

Brian Lowry

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