The explosion in issuance activity is a reminder that the bond market remains open for business, and this is an important development if the United States is to avoid a prolonged downturn. Since the Federal Reserve began rapidly raising interest rates to fight inflation, markets have become increasingly convinced that the United States is headed for a recession. This makes sense, of course, because the Fed has rarely managed to restore price stability without flipping the economy in the process. But any downturn is unlikely to be so severe as long as funding markets remain accessible to businesses. Although the market is having a particularly slow year for issuance, it’s not because of a “buyers’ strike” that has completely turned off the tap on new debt.
Instead, issuance slowed because companies became more wary of borrowing at those rates. As the housing market ground to a halt in the face of soaring mortgage rates, high-quality companies that could borrow at less than 2% in 2021 saw their yields hit nearly 5% earlier this year. The pullback in investment-grade debt to around 4.40% of late has again made borrowing slightly more palatable, and companies are taking the opportunity to stock up before benchmark interest rates spike or fall. a deterioration in the economic environment does not cause a widening of the gaps.
From a risk management perspective, this is a smart move for businesses. The recent rally has taken some of the upside out of the expectation. Some market participants believe the market is near the peak of Fed rate hikes, but that may be overly optimistic: if the Fed does indeed back off from its hawkish rhetoric and start considering rate cuts in 2023, it will likely be because the United States has slipped into a legitimate recession, which could mean that spreads will have widened further. Alternatively, if corporate bond spreads tighten from here, it likely means the economy has held up better than expected, giving the Fed more leeway to continue to tighten in its fight against inflation. Higher-duration, higher-quality bonds are, of course, particularly sensitive to changes in interest rates.
Clearly, the economic storm clouds demand attention from investors and issuers, and the outlook could change drastically by the end of the year. But like household balance sheets, the primary bond market appears to be another reason to believe the economy still has a little more vitality than some investors acknowledge. As long as companies can still raise cash, they are unlikely to face the kind of dire liquidity scenarios that typically accompany the layoffs and other desperate moves that are hallmarks of what most people consider a recession. .
More writers at Bloomberg Opinion:
• Fed can’t stop bond traders’ wishful thinking: Jonathan Levin
• The importance of Pelosi and Taiwan in bond fluctuations: John Authers
• Let’s not mince words as the economy heads south: Daniel Moss
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.
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