Record Corporate Bond Issuance Weighing on Credit Spreads

June 4, 2015

Record Corporate Bond Issuance Weighing on Credit Spreads Photo

Corporations have been issuing debt at a record pace during 2015, with borrowers rushing to beat the beginning of the Fed tightening cycle. In fact, corporate bond issuance levels during March and May of this year are ranked among the top three highest months ever. Share repurchase and strategic merger and acquisition (M&A) activity, fueled by today's easy monetary policy and low long-term interest rates, have also driven heightened levels of corporate borrowing.

On the demand side of the equation, declining appetite for risk on bank and broker/dealer balance sheets, investor fears about the end of the Federal Reserve's zero interest rate policy and less attractive corporate bond yields (resulting from the sharp drop in long-term treasury rates during 2014) have all contributed to the recent widening in investment grade credit spreads and steeper credit curves. Long-term investment grade corporate credit spreads, now in excess of 200 basis points, have moved 50 basis points wider during the past year.

Key Takeaway: Conventional wisdom suggests risk premiums should increase as the Federal Reserve begins to remove monetary policy accommodation. However, long-term investment grade credit spreads may actually be supported by a shift in the supply/demand dynamic that has been created by today's low-rate environment. Higher all-in yields for corporate debt will spur demand from pension plans (particularly those in the process of de-risking) and other institutional investors, while the pace of corporate debt issuance should slow in response to higher borrowing costs.

Tags: Chart of the Week | Corporate bonds | Credit | Credit spreads | Fed tightening

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