In my article of last week, I mentioned early signs of investors and corporate issuers accepting the new normal of higher credit margins. This notion has resulted in record issuance of Investment Grade (IG) corporate debt in the US together with a few sub IG issues.
Last week, companies outside of the financial sector sold a record $104bn of investment-grade bonds. In the sub IG space, Yum! Brands issued last week paying 7.75% for bonds maturing in 2025 compared to the 4.75% for the 10 year debt issued in September 2019 and this week, Wynn Resorts have issued bonds paying 7.75% maturing in 2025 compared to the 10 year debt paying 5.125% issued in September 2019.
How has the US credit market dislocation decreased so quickly?
Think of the debt capital markets like a house. The proper functioning of sovereign debt markets (eg US Treasuries and Australian Commonwealth Government Securities (AGS)) and semi government securities (Semis), underpin the functioning of bank financing (the ground floor) that in turn (or in parallel) underpins the functioning of corporate credit markets (the first floor): no functioning sovereign credit markets, no reliable bank and corporate credit markets.
In the case of the US, to accelerate the fast remediation of credit markets as well as inject liquidity into the financial system at a time of dislocation, the Federal Reserve (FED) has stepped in not only purchasing US Treasuries (“whatever it takes”), but Residential Mortgage Backed Securities (RMBS) as well as IG corporate issues. This is unprecedented. The FED, as buyer of last resort, has effectively coerced the credit markets into an accelerated, normalized functioning by intervening across all key credit markets. Indicative of the accelerated health of credit markets, again I refer to the recent issuances above. Credit margins have contracted accordingly indicating early signs of greater risk on, albeit at an early stage. The US CDX IG and US CDX HY decreasing 17% and 19% respectively off their recent highs in March.
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In Australia, a similar phenomenon has taken place: since late March, the RBA has engaged in $36 billion of AGS and Semi bond buying. The RBA made their intentions clear: targeting interest rate levels and to inject liquidity into the financial system. The RBA has not gone as far as the US in intervening in corporate bonds given they are less of a feature of the Australian capital market. That said, Australia has a very large RMBS market and the RBA accepts prime RMBS as collateral for short dated repurchase agreements (a further form of liquidity support).
Common across the US and Australia is that buying credit instruments is the mechanism to facilitate Quantitative Easing (QE).
Implications for corporate bond market in Australia
The net effect of the above is an acceleration of confidence and investors taking risk. There has been a smattering of corporate bond issues in Australia since COVID-19 (refer to the table below) but nothing sub IG. As mentioned last week, this is merely a question of time and heavily dependent upon the financial markets perception of the containment of COVID-19. Issuers be ready, it may happen sooner than you think.