Treasury sell-off sweeps in to US corporate bond market

The ferocious sell-off in US government debt markets has spilled into corporate bonds, nudging companies’ borrowing costs higher during a time when the economy is still recovering from the pandemic shock.

The average yield across US investment-grade bonds hit 2.28 per cent at the end of last week, according to an index compiled by ICE Data Services, up 0.17 percentage points since the end of February and 0.5 points so far in 2021. The rise in yields, which reflects a fall in prices, marks the bonds’ worst performance since Covid-19 struck a year ago.

Emerging signs of economic recovery, a quickening vaccine rollout and the recent passing of US president Joe Biden’s stimulus package have fuelled expectations of higher growth and inflation and jolted Treasury yields higher. That has eroded the value of bonds that offer fixed interest payments, especially higher quality corporate bonds that pay only a relatively small “spread” above Treasury yields. 

While the underlying reason for the decline in the credit market is positive, the rise in borrowing costs could counter Federal Reserve chief Jay Powell’s ambitions to keep his foot on the economic accelerator by keeping lending conditions easy. This has sharpened bond traders’ focus on the central bank’s upcoming meeting, which ends with a policy announcement on Wednesday.

“Powell needs to show a bit more concern about the rise in yields,” said Steven Oh, global head of credit and fixed-income at PineBridge Investments. “What you don’t want to do in the recovery phase is to counteract the fiscal stimulus with monetary tightening.”

Hans Mikkelsen, a credit strategist at Bank of America, said the recent increase in yields is “a little flavour of a big challenge for the next year to a year and a half in fixed income markets”.

“The economy is going to really take off and we are going to be back to normal in the US within the next couple of months . . . It’s going to be a very volatile and tricky environment for fixed income,” he added.

The improving economic outlook is positive for corporate creditworthiness and companies’ ability to repay debts. However, with much of the good news already priced in and yields at historic lows, there is little room to absorb the rise in rates stemming from the sell-off in Treasury markets.

“There is not much cushion to soften the blow,” said Fraser Lundie, head of credit at asset manager Federated Hermes, adding that the issue is compounded by the rise in longer-dated debt issuance, which is even more susceptible to the increase in Treasury yields. “There is much more sensitivity to underlying movement in rates,” said Lundie. 

In turn, the pullback has raised concerns over an exodus by investors that have facilitated companies raising record piles of cash over the past year.

As investors anticipate Treasury yields rising further, they are instead moving into floating rate investments like loans, or opting for lower quality debt supported by the economic recovery but less susceptible to the rise in interest rates, noted analysts. 

More than $2.5bn flowed out of funds that buy US investment-grade corporate bonds last week, according to data from EPFR Global. It marked the second-largest weekly outflow since the sell-off last year in March, surpassed only by a brief pullback in the build-up to the US presidential election in November last year.