Corporate bonds swing into loss amid hawkish Fed

U.S. investment-grade bonds have swung to a loss for the year as the Federal Reserve’s determination to raise interest rates to counter inflation spreads pain across debt markets.

The Bloomberg US Corporate Bond Index dropped 0.4% Wednesday, sending it into the red for the year after being up as much as 5% in early February. The gauge has slumped 2.7% in September, set for its biggest loss in seven months. 

The optimism many corporate-bond investors had at the start of 2023 has been shattered as a resilient economy spurred the Fed to raise its benchmark by a full percentage point to 5.5% this year, versus expectations in December it would hike by half that amount. Treasury yields have jumped to multiyear highs this month, adding to concern refinancing costs will hurt corporates that have been holding out for borrowing costs to turn lower. 

“Long-term yields are likely to continue to soar for as long as the Fed can convince markets it won’t need to cut rates aggressively in the foreseeable future,” Althea Spinozzi, senior fixed-income strategist at Saxo Bank, wrote in a note to clients. “’Higher-for-longer’ means ‘until-something-breaks’.”

September’s decline in corporate bonds has been driven by a rout in Treasuries that’s pushing up yields across credit markets. The spread on the corporate debt index over a similar Treasury gauge remains below 120 basis points, in line with its 10-year average.

SLOWER BUYBACKS

Companies are buying back bonds at the slowest pace since 2000, a hesitancy that may come back to haunt them as maturities pile up and interest rates stay higher for longer. Just 52 offers to repurchase outstanding debt have been made by North American firms, translating into $22 billion actually bought, the least since at least 2008, data compiled by Bloomberg show.

Investment-grade credit has been vulnerable since a US banking crisis broke out in March. The option-adjusted spread to Treasuries for a gauge of financial company bonds is near the widest in more than a decade relative to the spread for the broader corporate index.

“When looking at corporate bonds, we prefer quality over junk,” Saxo’s Spinozzi said. The highest yields among investment-grade corporates can be found in the front and the long part of the yield curve, she said.