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Long-term US corporate borrowing costs on the rise

Long-term borrowing costs for lower-quality US investment-grade companies are nearing 5 per cent — the highest level in nine months — as investors anticipate rising inflation and higher growth, reversing from the six-decade low touched earlier this year.

The average yield on the closely followed Moody’s Baa index has climbed to 4.9 per cent, the highest since March when the US credit market slowly recovered from a sharp sell-off at the start of the year.

The index includes long-dated bonds sold by companies that are rated Baa by Moody’s, constituting the lowest echelon within the investment-grade category. Yields fell as low as 4.15 per cent in July, a level last touched in 1956, as the universe of negative-yielding bonds swelled to nearly $14tn alongside central bank easing.

“We are moving from a belief that negative interest rates are with us forever to a belief that negative interest rates are harmful,” said Jeffrey Gundlach, chief executive of asset manager DoubleLine Capital. “The evidence is clear. You can’t keep doing the thing that doesn’t work and that’s why [the US is] shifting to fiscal stimulus.”

Rising corporate bond yields have been fuelled by a sell-off in sovereign debt markets after the election of Donald Trump as US president, with the yield on 10-year Treasuries briefly breaching 2.5 per cent this week, up from a low of 1.71 per cent on election night. Yields rise as bond prices fall.

The value of negative-yielding paper has since fallen below $11tn, according to Tradeweb, with investors readying for a spurt of government stimulus.

Attention has turned to Wednesday’s policy decision from the Federal Reserve and the US central bank’s rhetoric as it looks to 2017 and 2018. Economists with Goldman Sachs expect several policymakers to indicate a faster pace of tightening is possible over the next two years.

“The move itself is fully priced in, so that’s irrelevant,” said Michael Cloherty, a rates strategist at RBC Capital Markets. “It’s whether you think we will get a significant change in the forecast.”

Investor demand for US corporate paper has offset some of the losses tied to the decline in benchmark Treasuries. While yields have climbed, spreads — the difference in yield between corporate bonds and Treasuries of the same duration — have compressed. For the long-corporate US bond index from Bloomberg Barclays, spreads have fallen from 1.89 per cent on election day to 1.7 per cent this week. The index has nonetheless dropped 5 per cent.

Longer-maturing bonds have remained under pressure as investors are braced for the possibility of a wave of Treasury issuance to fund fiscal spending, as well as the possibility of debt that matures beyond the 30-year threshold.

Record highs for US equities are also weighing on the appetite for credit as investors rotate from bonds into shares, particularly cyclicals, financials and small-caps.

Analysts at Société Générale wrote this week that equities provided better value to investors than holding corporate debt in the eurozone and US, given a structural shift from monetary to fiscal policy impetus in developed countries.

“Normalisation of government bond yields could put further pressure on corporate bond yields. Furthermore, balance sheet releveraging and more shareholder-friendly policies . . . should support equity relative to credit in both the US and Europe,” they said.

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