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Investors race into US junk bond funds on rosier corporate outlook

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Investors piled back into funds that buy risky corporate debt in the US, boosted by the prospect that a coronavirus vaccine could help lift the fortunes of some of the hardest hit companies.

Funds that purchase US high-yield bonds took in $3.3bn for the week ending November 11, according to data from EPFR Global, the most in a month. The inflows reversed the nearly $3bn withdrawn in the days around the US presidential election.

Pfizer and BioNTech announced on Monday that their Covid-19 vaccine was more than 90 per cent effective, which has helped push the average yield on high-yield bonds to a record low of 4.82 per cent this week, according to data from Ice Data Services.

The news came after Joe Biden was declared the winner of the US presidential election, despite the Democratic party falling short of a comprehensive “blue sweep” of Congress. Without a firm majority in the Senate, investors expect some of Mr Biden’s less market friendly policies, such as a sharp increase in corporate taxes, to be reined in, while still viewing the president-elect as offering more political stability on foreign policy.

Junk bond spreads, the premium in borrowing costs investors demand to hold the assets over haven government bonds, had already fallen from a recent high of 5.75 percentage points at the end of October to 5.05 percentage points at the end of last week on the result.

Column chart of Weekly flows into US high-yield corporate bond funds ($bn) showing Investors add to US junk bond funds after vaccine news

Bonds issued by Royal Caribbean Cruises, American Airlines, United Airlines and theatre operator Cinemark — among the companies jolted by the crisis — have rallied over the past week, according to trading platform MarketAxess. Royal Caribbean bonds that mature in 2028 changed hands on Thursday at 81 cents on the dollar, up from 74.5 cents last Friday, data from Finra showed.

“It’s been something to write home about,” said Jerry Cudzil, head of credit trading at asset manager TCW. “There has been a real rush into risk over the last week.”

This has helped push high-yield bond returns up from roughly flat coming into the month to about 3.5 per cent, erasing losses sustained during the heat of the pandemic-induced sell off in March.

Line chart of Yield on the ICE BofA US high yield index (%) showing Yields on US junk bonds hit a record low

Investors, starved of higher yields in safer assets such as US government bonds, have poured into corporate credit in the hope of generating better returns, even after the dramatic rally over the past week.

“You have to look at where the equity market is priced, where high grade markets are. Having an allocation to high yield will serve investors well,” Kevin Lorenz, a high yield portfolio manager at Nuveen, added.

Andrzej Skiba, head of US credit at BlueBay Asset Management, said that investors were shifting out of lower yielding areas of fixed income in search of the higher payouts on offer on junk debt. He added that weakness in the dollar and lower hedging costs were boosting the appeal of US credit for foreign investors, particularly those in Asia.

“Global saving pools are growing and people are desperate for yield,” he said. “People are realising fixed income does not give you the same return away from the high-yield universe.”

However, with the prospect of still elevated default rates, even with the recent vaccine announcement, investors also aired caution, suggesting the rapid decline in yields in the high-yield bond market was no longer compensating investors for the possibility of companies reneging on their debts.

“It’s risk without much return,” said Mr Cudzil. “It’s potentially extremely dangerous.”



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Coinbase: digital marketing | Financial Times

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Coinbase will be a stock riding a runaway train. The US cryptocurrency platform wants investors to think long term about the prospects for a global “open financial system”. Most will be unable to tear their eyes away from wild, short-term price swings in bitcoin, the world’s largest digital asset. 

This has its benefits. Coinbase, which has filed for a US direct listing, makes most of its money from commissions on crypto trades. Sales more than doubled to $1.3bn last year. The company has swung from a loss to net income of $322m as crypto prices jumped.

But the company has given no detail on the financial impact of the 2018 bitcoin price crash. Will Coinbase’s 2.8m active retail users and 7,000 institutions hang on if there is another protracted price fall? 

Coinbase was valued at $8bn in a 2018 private funding round and $100bn in a recent private share sale, according to Axois. That rise looks remarkably similar to the increase in bitcoin’s price from less than $5,000 to more than $50,000 this year.

The rally is hard to justify. Bitcoin has not become a widely used currency — nor is the US ever likely to countenance that. It offers investors no yield. Volatility remains high. Elon Musk’s tweet this weekend that bitcoin prices “seem high lol” propelled a sharp fall that hit shares in crypto-related companies. Shares in bitcoin miner Riot Blockchain have lost a quarter of their value this week. 

Prospective investors in Coinbase should keep this in mind. Its listing will take cryptocurrencies further towards the financial mainstream. But risk factors are unusually numerous, including the volatility of crypto assets and regulatory enforcement. 

Both threats are widely known. Another risk factor in the listing document deserves more attention. Vaccination campaigns and the reopening of shuttered sectors of the economy is raising yields in safe assets such as Treasuries. Risky trades may become less attractive. Coinbase might be about to go public just as the incentive to trade cryptocurrencies is undermined. 

If you are a subscriber and would like to receive alerts when Lex articles are published, just click the button “Add to myFT”, which appears at the top of this page above the headline.

This thread is closed to comments due to a history of posts on this subject that breach FT user guidelines



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US stocks make gains on Fed message of patience over monetary policy

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Stocks on Wall Street reversed earlier losses after Jay Powell, the Federal Reserve chairman, reiterated the central bank’s desire to stick with accommodative policies during his second day of testimony to Congress.

The tech-heavy Nasdaq Composite ended the day up 1 per cent, having fallen almost 1 per cent at the opening bell. The S&P 500 climbed 1.1 per cent, marking the blue-chip benchmark’s second consecutive rise after five sessions of back-to-back losses.

A morning sell-off in US Treasuries also faded, with the yield on the 10-year note having climbed as much as 0.07 percentage points to slightly less than 1.43 per cent, its highest level since February last year, before settling back to 1.37 per cent.

Treasuries have been hit by expectations that US president Joe Biden’s $1.9tn stimulus plan will stoke inflation, which erodes the cash value of the debt instruments’ interest payments. However, the more recent rise in yields has also been accompanied by a rise in real rates, which are more indicative of the return investors make after inflation and signal an improving growth outlook for the economy.

Higher yields, which move inversely to the price of the security, also knock-on to equity valuations by affecting the price-to-earnings multiples investors are willing to pay for companies’ shares. A higher yield, analysts say, makes fast-growth companies whose earnings represent a slim proportion of their stock market value less attractive in comparison.

Shares in the 100 largest companies on the Nasdaq are valued at a multiple of 37 times current earnings, against 17 times for the global FTSE All-World index of developed market equities.

“When bonds yield close to zero, you are not losing out by investing in those companies whose cash flows could be years into the future,” said Nick Nelson, head of European equity strategy at UBS. “[But] as bond yields start to rise, that cost of waiting [for companies’ earnings growth] increases.”

Earlier on Wednesday, investors’ retreat from growth stocks rippled into Asia. Hong Kong’s Hang Seng index sank 3 per cent, its worst daily performance in nine months. Chinese investors using market link-ups with bourses in Shanghai and Shenzhen dumped Hong Kong-listed shares at a record pace, selling a net HK$20bn ($2.6bn) on Wednesday. China’s CSI 300 index fell 2.6 per cent. Japan’s Topix slipped 1.8 per cent, dragged down by tech stocks.

Column chart of Hang Seng index, daily % change showing worst day for Hong Kong stocks in 9 months

European equity markets closed higher, with the Stoxx 600 regional index rising 0.5 per cent and London’s FTSE 100 index up 0.5 per cent. UBS’s Nelson said European equities were less vulnerable to rising yields because European stocks generally traded at lower valuations than in Asia and the US. “We have fewer big technology companies here.”

While the bond market ructions have unsettled many equity investors, some believe this should not affect stock markets because the inflation expectations that have driven the Treasury sell-off are linked to bets of a global recovery.

“Rising bond yields and rising inflation from low levels provide a historically attractive environment for equities,” said Patrik Lang, head of equity strategy and research at Julius Baer. Traditional businesses whose fortunes are linked to economic growth, such as “industrials, materials and especially financials”, should do better in a reflationary environment than tech stocks, added Lang.



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Fed needs to ignore ‘taper tantrums’ and let longer rates rise

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The writer is chief executive officer and chief investment officer of Richard Bernstein Advisors 

The Ferber Method, a sleep training technique, teaches babies to self-soothe and fall asleep on their own. It’s as much a training technique for new parents to ignore their baby’s crying as it is for the child to learn to cope by themself. 

The US Federal Reserve should consider Ferberising bond investors and ignore future “taper tantrums” like the market disruption that occurred when the central bank signalled tighter monetary policy in 2013. The long-term health and competitiveness of the US economy may depend on bond investors’ self-soothing ability to cope with reality.

The slope of the yield curve is a simple model of the profitability of lending. Banks pay short-term rates on deposits and other sources of funds and receive longer-term rates by issuing mortgages, corporate loans, and other lending agreements.

A steeper curve, therefore, is a simple measure of better bank profit margins, and has in past cycles spurred greater willingness to lend. Historically, the Fed’s Survey of Senior Bank Lending Officers shows banks have been more willing to make loans to the real economy when the yield curve has been steeper.

A chart showing how banks have been more willing to lend with a steep yield curve. As the slope on the US treasuries  10-year-less-2-year yield curve has steepened, so the net percentage of banks reporting tighter lending standards has fallen

With that simple model of bank profits in mind, textbooks highlight the Fed’s control of short-term interest rates as a tool to control lending. The Fed reduces banks’ cost of funding and stimulates lending when it lowers interest rates. But it increases funding rates and curtails lending when it raises short-term rates. Coupling lower short-term rates with a steeper yield curve can be a powerful fillip to bank lending. 

However, policies in this cycle have been unique. As US short-term interest rates are near zero, the Fed has attempted to further stimulate the economy by buying longer-dated bonds and lowering long-term interest rates. Those actions have indeed lowered long-term borrowing costs in the economy, but banks’ willingness to lend has been constrained because lending margins have been narrow and risk premiums small.

Banks in past cycles might have been willing to lend despite a relatively flat yield curve because they could enhance narrow lending margins by using leverage. However, regulations after the financial crisis now limit their ability to use leverage.

This policy and regulatory mix has fuelled some of the growth in private lending. Private lenders are not subject to regulated leverage constraints and can accordingly lend profitably despite a flat curve. The growth in private lending effectively reflects an unintended disintermediation of the traditional banking system. This has meant liquidity destined for the real economy has largely been trapped in the financial economy.

The yield curve has started to steepen, and the Fed should freely allow long-term interest rates to increase for monetary policies to benefit the real economy more fully. Allowing long-term rates to increase would not only begin to restrain financial speculation as risk-free rates rise, but could simultaneously foster bank lending to the real economy. 

Thus, the need for the Fed to Ferberise bond investors. Banks’ willingness to lend is starting to improve as the curve begins to steepen, but some economists are suggesting the central bank should continue its current strategy of lower long-term interest rates because of the potential for a disruptive “taper tantrum” by bond investors. The Fed needs to ignore investors’ tantrums and allow them to self-soothe.

The investment implications of the Fed allowing longer-term interest rates to rise seem clear. Much of the speculation within the US markets is in assets such as venture capital, special purpose acquisition vehicles, technology stocks and cryptocurrencies. These are “long-duration” investments that have longer-time horizons factored into their valuations. They underperform when longer-term rates rise because investors demand higher returns over time. Capital would be likely to be redistributed to more tangible productive assets.

Investors and policymakers should be concerned that monetary policy is fuelling speculation rather than supporting the lending facilities needed to rebuild the US’s capital stock and keep the country’s economy competitive.

Like a new parent to a baby, the Fed should not rush to coddle bond investors’ tantrums and should let the financial markets soothe themselves. Short-term financial market volatility might cause some sleepless nights, but the Fed could unleash the lending capacity of the traditional banking system by letting the yield curve steepen further.



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