Bond Outlook February 18th

When bank lending dries up, what do corporations do to obtain new funding? They turn to the bond markets, and the bond markets are welcoming them. Fortunately for corporate issuers, fixed-income investors are subscribing to new issues, something close to sight unseen. The yields offered by the issuers are higher than those of their existing bonds. However, the issuers are happy to lock in funds at what is still an attractive interest cost, while the buyers are delighted to achieve yields 300 bps and more above governments.

Until now we have encouraged our clients to take partial profits on over-valued government bonds and to deploy resources to high-quality corporates. We have stressed the need to choose issuers with steady cash flows. That advice still stands, but greater care than ever is needed in corporate bond selection:

• New issues are now being successfully marketed with ratings near the bottom of the investment grade range
• The secondary market for old bonds by the same issuers has practically dried up
• Secondary markets for the new issues are not functioning efficiently either, not least because bid/offer spreads remain so high
• All secondary markets are now illiquid as a result of market makers declining to take positions for fear that new issues will sharply reduce the value of their inventory in the same names

Thus, although we have some satisfaction in seeing bank loans moving to bond markets, normal service is far from being resumed in these markets.