With interest rates at record lows, investors are desperate for yield. So they have entered the corporate-bond market in droves. In the fourth quarter of 2012, US non-financial businesses issued $782bn of bonds at an annualised rate, a record high. Yields, which move inversely to prices, have plummeted since the crisis.
The average yield on US investment-grade paper is now around 3%, half the 2008 level. British investment-grade yields have also hit record lows.
The riskier end of the company-debt market has been buzzing too. In the second half of 2012, US issuance of junk (non-investment-grade, or high-yield) debt reached a record. US junk yields have fallen to under 6% from 16% at the peak of the crisis. The first quarter of 2013, moreover, is on track to set a European record for issuing junk paper.
This is all getting out of hand, says John Plender in the Financial Times. Markets have decided that “large, cash-generative” international firms are a safer bet than indebted governments. Nestlé has been able to borrow more cheaply than the French government. But now this logic has been extended beyond solid multinationals to “many singularly unappetising borrowers”.
Bond guru Bill Gross of Pimco is also wary. “Corporate credit and high-yield bonds are somewhat exuberantly and irrationally priced,” he says, and profit margins look stretched and “the economy is still fragile”. US earnings and GDP growth estimates have fallen of late; Europe remains in recession; and China is weakening.
The corporate credit boom has gone beyond levels justified by the fundamentals, but the party could go on for some time. As Plender notes, “when the monetary tap is turned on, it is dangerous to shun risk assets”. The liquidity tide is sweeping all before it, overriding fundamentals.
Central banks are unlikely to tighten this year as the recovery still looks weak. While all this money printing could end in a jump in inflation, that could still be some way off.
A jump in defaults could also call time on the bond party. But with interest rates set to stay low, therefore allowing troubled firms to service debts, this is most likely to occur if firms go on a wild spending spree with borrowed money, says The Economist’s Buttonwood columnist. But with mergers and acquisitions in the early stages of a recovery, this won’t happen yet. The incipient corporate bond bubble “probably has a bit more inflating to do” before it meets a pin.