Corporate bonds

Demand for corporate bonds pushes inflation-adjusted yields to zero

The average yield on investment-grade U.S. corporate bonds is now below a key measure of investors’ inflation expectations, a first that shows how much demand for fixed-income assets is reducing their potential returns.

On Friday, the expected annual inflation rate over the next decade – derived from the difference in yield between nominal and inflation-adjusted 10-year US government bonds – stood at 1.89%, according to the Federal Reserve Bank of St. Louis. According to data from Bloomberg Barclays, the investment grade corporate bond yielded just 1.85% on average.

So-called real yields – or the return investors can expect from bonds after adjusting for inflation – have been below zero for months on US government debt. But last week marked the first time in records dating back to 2003 that the phenomenon spread to a broad corporate bond index.

The two situations are linked; negative real yields on US Treasuries are causing investors to buy riskier assets in search of better returns. Many have turned to corporate bonds, pushing yields to new lows in recent months, investors and analysts said.

The yield on the benchmark 10-year Treasury inflation-protected security – a proxy for real Treasury yields – is currently around minus 0.97%. This means investors can still earn a significant return by buying corporate bonds.

“Most individuals and institutions do not have the luxury of being [invested in] 100% equities,” said Nicholas Elfner, co-head of research at Breckinridge Capital Advisors, which specializes in investment-grade bonds.

The choice, therefore, is not at all whether to buy corporate bonds, but how much to buy relative to Treasuries, and investment-grade bonds remain “a way to add extra yield,” he said. Mr Elfner.

The most recent drop in real corporate yields was helped by a burst of economic optimism. Over the past month, yields on 10-year US government bonds have climbed to 1% in response to progress on coronavirus vaccines and new spending legislation designed to move the economy forward until that these vaccines are widely distributed next year.

The yield on the benchmark 10-year U.S. Treasury stood at 0.928% on Monday, according to Tradeweb, down from 0.967% on Friday but up from 0.768% on Nov. 4. Treasury yields tend to rise when the economic outlook improves, as faster growth can lead to higher inflation and possibly interest rate increases from the Federal Reserve.

The same developments fueled a rise in market-based inflation expectations. Even so, corporate bond yields fell as the improving outlook made investors more confident that companies would service their debts.

For businesses, falling corporate bond yields are welcome news, allowing them to borrow at rates that would have been unthinkable just a few years ago.

Last week, Bank of New York Mellon Corp.

issued $750 million of three-year bonds at a yield of 0.386%, the lowest on record for that maturity, according to LCD, a unit of S&P Global Market Intelligence. In the secondary market, a Microsoft Corp.

The 2022 bond last traded on Dec. 1 with a yield of 0.196%, just 0.03 percentage points above the comparable U.S. Treasury yield, according to MarketAxess.

Andrew Karp, head of global investment-grade capital markets at BofA Securities, said issuance of investment-grade corporate bonds is expected to decline next year from its record pace this year, largely because that companies have already done so much to raise cash and extend debt maturities in recent months.

Still, he said, companies are “certainly still intrigued by the possibility of locking long-term rates at levels that are still historically attractive.”

Up to four million small businesses could disappear in 2020, analysts say, as the pandemic weighs heavily on local economies. The WSJ visits Yuma, Arizona, where small business owners say another round of congressional stimulus may be too little too late. Photo: Adam Younker for the Wall Street Journal

Write to Sam Goldfarb at [email protected]

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Appeared in the print edition of December 8, 2020 under the title “Yields for Corporate Bonds Retreat”.