Bond issuers blaze away as US buyers ignore oil fears
US and foreign bond issuers took full advantage this week of a schizophrenic US high grade bond market, which has been surging higher even though valuations are already full, spreads are tight, oil prices are rising and the Federal Reserve clearly intends to continue its measured series of rate increases.
Borrower after borrower moved to lock in rates before they rise again ? and deal after deal was snapped up by investors, who seem convinced the economic recovery is slowing and they will have to seek yield from credit plays.
Eli Lilly, the Aa3/AA rated drug company, almost doubled its $600m three year floating rate note to $1bn, added a one year call and still priced the bond on top of comparables.
Singapore?s United Overseas Bank not only increased its minimum $500m upper tier two deal to $1bn but tightened official price guidance of 117bp over Treasuries to 114bp. The 15 year non-call 10 bond continued to tighten to around 112bp in the aftermarket.
The Royal Bank of Scotland brought out $1bn of institutional and retail tier one securities, but demand was so overwhelming that it ended up raising $2.4bn.
The bank priced its institutional tranche tighter than comparable secondary paper on a Libor basis, although rival issuers such as HBOS have recently had to pay a 5bp-7bp premium for smaller deals.
Investors quickly soaked up $750m of 3.75 year floating rate MTNs from GMAC, increased from $500m.
Smaller deals from names including LG Caltex Oil, John Deere Capital, Alabama Power and Pacificorp were pounced on by investors and traded up on the break.
In their enthusiasm, buyers seemed to ignore the fact that oil hit a record $47 this week and looks set to top $50. Nor did they flinch at the Fed?s 25bp rate hike last week and its plans to continue raising rates at a measured pace.
?We?ve had a counter-intuitive trend taking place in the last several days where equity markets have risen and corporate bond spreads tightened, despite oil prices still rising,? said Edward Marrinan, high grade corporate bond strategist at JP Morgan. ?Last week, spreads and equity markets were weakening because of fears of oil prices rising. So what is going on here??
Analysts believe the bond market has been caught in a tug of war. At one end of the rope are very strong technical conditions, with plenty of money available for investing.
At the other end are the full valuations of bonds, rising interest rates, soaring oil prices and threats of terrorism.
?Both sides are roughly balancing each other out and keeping the market in a very tight range,? said Marrinan.
This week, investors? perennial struggle to get enough in the way of new bonds overwhelmed the danger signals and caused secondary bond spreads to tighten.
Yet only last week, oil prices upset the equity market and disturbed a pumping $10bn week of new bond issuance, causing spreads in the secondary market to weaken slightly.
The one stable factor in it all is the primary bond market, which continues to offer perfect issuance conditions for borrowers, as long as the deals are priced fairly.
The feel good factor
?The credit market feels as good as it has felt since the beginning of the year,? said Jim Merli, global head of fixed income syndicate at Lehman Brothers in New York.
?The thing I can attribute the strength of the market to is the build-up of cash levels,? he said. ?On a net basis, there was virtually no new fixed rate investment grade supply from the end of March to the beginning of August.?
August has been an unseasonably good new month for new issues, with $22bn of deals already.
Even so, new issuance of fixed rate high grade bonds is down about 19% year-to-date. Especially thin on the ground are the classic industrial issuers.
?We?ve seen a lot of non-frequent issuers jumping into the market to take advantage of tight spreads and Treasury yields that have rallied over 20bp in recent weeks,? said one syndicate manager. ?They want to lock in those rates before the Fed starts raising rates again.?
As investors? confidence in the economic recovery has ebbed, the 10 year Treasury yield has slipped from 4.56% at the beginning of July to 4.45% on August 2 to 4.22% yesterday (Thursday).
With yields declining, risk appetite has increased. Investors are willing to accept unusual structures, such as UOB?s $1bn upper tier two bond ? Singapore?s largest sub deal and its first to use a 15 year non-call 10 structure for upper tier two bonds.
?This structure is unusual for the US,? said one banker. ?Typically when we get tier one or upper tier two deals they are perpetual and step up in year 10. This is just a 15 year non-call 10.?
At the root of investors? broad-mindedness is a change in interest rate expectations. Although it raised rates last week, the Fed is expected to become less hawkish, after a series of weaker than expected US economic data announcements, beginning with July?s disappointing employment numbers.
?More people are now thinking the Fed might not be as aggressive in terms of the magnitude and frequency of rate hikes because the rise in oil prices is doing the Fed?s job for them by having a moderating effect on economic growth? says Marrinan.
Some investors were also positioning themselves for what is expected to be a busy September and, barring any unforseen events, a strong fourth quarter.
?We are thinking that the corporate basis should be constructive for the latter part of the year,? said Joe McCusker, auto analyst with FTN Financial in New York.
?Typically after Labor Day [September 6], the market gets refocused and risk tolerance goes up because people are back from vacations and inventories increase on the street.?