January just witnessed a record amount of new investment grade (IG) corporate bond issuance. The US$194bn was nearly 50% higher than the monthly average over the last four years. This comes on the heels of US$1.2tn in each of the last two years and against the backdrop of the US$7.7tn market value of the Bloomberg Credit Index.1 February is forecast to see at least US$150bn more, again well above historical averages for the month.
Why this sudden rush to issue debt? Of course, companies have an ongoing need to refinance maturing debt. But a large base of buyers hungry for yield has emerged. Markets perceive the US Federal Reserve will begin cutting rates in the first half of this year, which would lead to a drop in market yields. The Bloomberg Credit Index reached 5.00% at year-end 2023, at a discounted price of US$93.70 – well below its longer-term average. As an investor, why not lock in these high yields and contractual coupon rates now, then pick up the price appreciation as they decline?
Why not lock in these high yields and contractual coupon rates now, then pick up the price appreciation as they decline?
The economic backdrop measurably improved over the course of 2023. Market forecasters had almost uniformly predicted a recession, brought on by job losses, falling consumer confidence and spending, and a general contraction in economic activity. Not only has that not happened, but growth actually picked up in the third quarter, to an annualised rate of 4.9%, before cooling to a 3.3% rate in the fourth. The Atlanta Fed’s GDPNow, a real-time model, is running above 4% in the first quarter of 2024. US job gains have increased over the last two months, the unemployment rate has remained below 4% for the last two years and consumer confidence has steadily improved.
As these prospects have improved, investment grade credit spreads have tightened to levels last seen before the Fed started raising rates in March 2022. Credit fundamentals also have improved. Rating upgrades are outpacing downgrades, and consensus is forecasting revenues in 2024 to be 5% higher and earnings-per-share gains to top 11%. With the Fed’s December shift from combatting inflation to preventing recession – still the plan despite some recent pushback by officials – it seems likely credit spreads will be range bound around these levels.
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1 All data, Bloomberg as at 6 Feb 2024.
