Spreads Narrow As Corporates Show Mettle

A range of opinions swathes the outlook for the U.S. bond market as the clock ticks ahead of a deadline the weekend after next by which time lawmakers must agree to raise the nation’s lofty debt ceiling. Some say that failure to raise the ceiling that would likely result in a default would increase yields in a heartbeat by almost one full percentage point. And while time is running out, others are more sanguine and say that a deal will be struck in time to save the nation from a sovereign downgrade. Although the government bond market suffered faring only mildly losses on Wednesday, some investors headed for corporate debt as stocks sold off globally.

Non-Investment Grade

HCA Inc. (HCA) – Hospital chain HCA said it would issue more high-yield paper yesterday running the possibility that it would buy out some of its established notes due maturing within nine-years in an effort to lower its cost of capital. In the non-investment grade universe HCA’s 9.25% notes maturing November 2016 and its 7.25% paper maturing September 2020 were the two most widely traded bonds on Wednesday with a total of $32mm changing hands. Its five-year debt is rated B2 by Moody’s and its lower-coupon 2020 maturity is rated Ba2. HCA today issued $5 billion in notes maturing in February 2020 and February 2022 at yields of 6.5% and 7.5% respectively as it reduced its borrowing costs.

Investment Grade

Deere & Co. (DE) – The price of bonds issued by agricultural machinery-maker John Deere slipped by 23 cents per $1,000 invested on Wednesday but relative to U.S. treasuries, the yield outperformed. The company’s July 2021 maturity carrying a coupon of 3.90% was well-wanted in Wednesday’s market allowing its premium over the government issue to narrow by two basis points to 67 basis points. With $35mm of its A2-rated issue changing hands on Wednesday, Deere paper was the second most active issue throughout the session behind Bank of America’s 10-year deal.

Kraft Foods Inc. (KFT) – But the bigger mover was worldwide food-manufacturer Kraft, whose Baa2-rated February 2040 issued muscled ahead sending its yield lower and in the opposite direction of the comparable government issue. Debt-ceiling woes again weighed on the U.S. treasury market lifting yields across the curve into the afternoon with the long end losing ground adding three basis points to the 30-year yield. By comparison a $1.50 jump per $1,000 investment in the price of Kraft’s longest-dated issue saw its yield shed 12 basis points narrowing the gap by 15 pips on the day to 120 basis points. Demand for the safety of Kraft’s paper was evident even as its share price slipped to the lowest in four weeks.

Muni-Bond Corner – Thirty-day total visible supply has declined to $7.7 billion from a recent high of $12.1 billion on July 19th. Supply of $4.1 billion in new issuance is on the agenda this week and compares to $8.3 billion last week. In the background continues the raging debate over the debt-ceiling, which if unresolved could result in a sovereign default with the nation unable to pay its bills even if only on a temporary basis. In such event stands the potential downgrade of 7,000 U.S. muni-credits. Issuers with advanced refunded bonds (where a bond is issued to pay off another outstanding bond and the proceeds are invested in treasuries) may run the risk of falling victim to a downgrade. Debt service on advance refunded bonds typically is paid from an escrow account funded with treasury securities. Issuers are on the sidelines as they await a resolution to the budget/debt-ceiling negotiations. The state of California secured a loan $5.4 billion from eight banks as insurance for any market disruption should the U. S. default. The market is uncertain as the question to drive the next move in interest rates is whether buyers have excess cash on the sidelines or whether issuers will bring new supply to the market.

About Andrew Wilkinson 1023 Articles

Affiliation: Interactive Brokers

Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.

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