Financial Market

Roll up, roll up for the great blue-chip corporate bond sale!

If there was a storefront for the corporate bond market at the moment, it would likely to be plastered with hyperbolic signs for the sale of a lifetime.

“10 per cent off all bonds!” one sign might read. “Close to 40 per cent off blue-chip company debt!” another could say. When will this sale end? Probably only once we get closer to a recession.

Until then, we are left with a curious situation in which the market value of bonds issued by the likes of Alphabet, the Google owner and one of the most highly rated companies in the world, is trading lower than the average price of the most lowly rated bonds available.

Alphabet’s bond maturing in almost 30 years’ time in 2050 can be bought for about 65 cents on the dollar. What a bargain! That is a 35 per cent discount from when the bond was issued with a record low coupon in August 2020.

Investors can buy Alphabet bonds for the same price as the debt of much lower-rated companies such as WeWork and Carvana. And for the same price would you rather lend money to a co-working company that almost went bankrupt, a struggling car dealership, or one of the most highly valued companies on the planet?

Obviously, this is a little facetious and not a wholly fair comparison. Price is only one component of the value of a bond to an investor. Alphabet’s bond yields just over 4 per cent through to its maturity well in the future. Carvana’s similarly priced bond yields 16 per cent and it matures in 2027, with the higher potential return indicative of the higher perception of risk.

However, as fears over a recession intensify, it is also not a completely wild comparison to make. “The premise is not silly,” said Oleg Melentyev, head of high yield bond strategy at Bank of America. “We are hearing it from professional high yield investors.”

This is because as recession fears mount, investors are not as assured of realising the higher yield on offer from low-rated companies because they may simply default. And after years of scratching around in the darkest corners of financial markets looking for yield, the prospect of a decent return lending to a high-quality company is making investors rethink what they want to own, said Melentyev.

“In high yield, when something trades at a low price, it usually implies a significant probability of default,” he said. “The yield doesn’t matter as much because you probably won’t recover that yield. Therefore, if you have high-quality bonds trading for the same dollar price then maybe they are more attractive.”

This odd situation is brought about by the peculiarity of the current economic cycle compared with those that have recently passed. When Lehman Brothers went bust in September 2008, the lower end of the Federal Reserve’s target for US interest rates stood at 2 per cent. That is higher than the current 1.5 per cent lower “bound”, and that is after some aggressive interest rate increases from the Fed.

More importantly, in the run-up to Lehman’s collapse, the Fed had already cut rates from more than 5 per cent in 2007. That meant that as recession risk rose and the risk of lending to companies increased, monetary policy became looser, supporting businesses. This time around, not only are recession risks rising and the risk of lending to companies increasing, but the Fed is also raising rates to tame inflation.

The see-saw that usually means monetary policy moves in the opposite direction to credit risk is broken. Even the debt of seemingly recession-proof companies is getting wrapped up in the credit market sell-off.

The average price of investment-grade bonds is now about 92 cents on the dollar. It was not until the day Lehman collapsed on September 15 2008 that the market reached breached this level last time around.

“It makes no sense,” said Melentyev. “These historical relationships are being distorted because the investment-grade market is in a place it hasn’t been for a long time.”

This distortion may not cure itself until the Fed begins to lower interest rates again. It is unlikely to do that until we are much closer, or even in, a recession.

Markets may also play a role. Investors are likely to gravitate towards higher-quality debt as the risk of recession increases, adding to demand for investment-grade bonds.

Companies also have an interesting choice to make. For those that do not need the cash, they have a chance to buy back their own debt at a tremendous discount. However, in doing so, they might be giving up debt locked in at cheap interest rates that now seem unlikely to come around again anytime soon.

“Companies should at least be looking at their discounted bonds and discussing if they should be doing anything about it,” said Melentyev. After all, the sale is going to end sometime.”

joe.rennison@ft.com

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