JPMorgan confronting BofA-led bond bears on loss: credit markets
The biggest investment-grade bond loss in 14 months is bolstering Bank of America Corp.'s view that the unprecedented bull market in the notes is over. JPMorgan Chase & Co. disagrees.
With bonds of the most-creditworthy borrowers from the U.S. to Europe and Asia losing 0.8 percent in January, Bank of America strategist Hans Mikkelsen cut his forecast for investment-grade debt returns last week, saying a sustained shift away from notes will cause borrowing costs to soar. At JPMorgan, Eric Beinstein said he's skeptical bond losses will deepen because the biggest debt buyers are unlikely to switch to equities and central banks will keep supporting the market.
Debt strategists at the two biggest U.S. banks are coming into conflict after a 44 percent rally since 2008 left yields at a record-low 2.55 percent in December and the best start to a year for stocks in two decades added $2.6 trillion to their market value. JPMorgan anticipates more government stimulus that bolsters credit as the International Monetary Fund lowers its forecast for global growth.
"Despite concerns about a potential rotation out of credit, demand for investment-grade debt will continue to be supported," Greg Hall, managing director in debt capital markets at Barclays Plc in New York, wrote in an e-mail.
Federal Reserve Chairman Ben S. Bernanke signaled Jan. 31 he isn't close to easing up on $85 billion in monthly bond purchases to spur the economy and bring down unemployment, which climbed last month to 7.9 percent from 7.8 percent in November and December.
Corporate bond sales of all ratings surged 86 percent last month to $419.5 billion, the busiest January on record, as borrowers sought to lock in borrowing costs that climbed from record lows.
The extra yield investors demand to hold the bonds rather than government debentures ended last week at 214 basis points, or 2.14 percentage points, after reaching 205 on Jan. 28, the least since May 2011 on the Bank of America Merrill Lynch Global Corporate & High Yield index.
A disorderly rotation causing borrowing costs to soar "is the biggest risk to investment grade this year and the one we are getting increasingly concerned about," strategists led by Mikkelsen said in a Jan. 28 report. "We now consider it most likely that total returns will fall short of our low 1.6 percent target."
Beinstein's team, in a Feb. 1 note, wrote "spreads will modestly tighten over time" and "a meaningful spread selloff is unlikely despite the low returns in high-grade credit year- to-date."
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing 2.9 basis points to a mid-price of 89 basis points at 11:07 a.m. in New York, according to prices compiled by Bloomberg.
The gauge typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, increased 0.5 basis point to 16.5 basis points as of 11:07 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.
Bonds of Charlotte, North Carolina-based Bank of America are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 5.1 percent of the volume of dealer trades of $1 million or more at 11:09 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Investment-grade bonds globally declined the most last month since November 2011, when they lost 1.9 percent, and followed a return of 10.8 percent in 2012, according to the Bank of America Merrill Lynch Global Corporate index. The MSCI World Index gained 5 percent, the most since October 2011 and the best January since 1994.
"The pressure, especially if we're looking at an economic rebound, is that rates are going to go higher and spreads have little room to offset some of the rising rate impacts," Thomas Chow, a money manager at Delaware Investments in Philadelphia with about $170 billion under management, said in a telephone interview. "That's why we saw a negative return in January and we're probably going to see instances going forward of that."
Investors have been tempering their enthusiasm for bonds, putting $21.3 billion into debt funds in January, about one- third the $57.8 billion they poured into stock funds, according to EPFR Global data. That follows an unprecedented $493.5 billion of flows into bonds globally last year.
The iShares iBoxx Investment Grade Corporate Bond Fund, the exchange-traded fund that owns $24.3 billion of securities, recorded an outflow of 6.3 million shares in January, equal to about $748.1 million, Bloomberg data show. That's the biggest monthly redemption of shares for the fund since December 2010.
For Mikkelsen, bonds' performance now looks worse than he would have expected, the strategist said.
If the 10-year Treasury yield rises to 2.5 percent by the end of June, "the rotation starts because performance is going to look really bad," he said.
Treasury 10-year note yields climbed 7 basis points last week to 2.02 percent, according to Bloomberg Bond Trader data. They reached 2.04 percent, the highest since April 13.
Facing sustained losses, investors may pull their money out of mutual funds that invest in bonds, creating forced sellers, according to Citigroup Inc. strategists led by Stephen Antczak in New York.
After "powerful" one-way inflows for several years, bond investors may find themselves in "uncharted waters" if the trend reverses, credit strategists led by Edward Marrinan at RBS Securities in Stamford, Connecticut, wrote in a Feb. 1 report.
The IMF cut its global growth forecast to 3.5 percent this year, down from a 3.6 percent forecast in October, the Washington-based agency said Jan. 23. It now projects a second year of contraction in the euro region as progress in battling Europe's debt crisis fails to produce an economic recovery.
The Fed has held its benchmark interest rate at zero to 0.25 percent since December 2008 in an effort to boost economic growth and cut the jobless rate following the worst financial crisis since the Great Depression. Policy makers who provided forecasts in December were "approximately evenly divided" between those who said it would be appropriate to end the purchases around mid-2013 and those who favored a later date, Fed minutes said.
Effects from the government's bond purchases are big enough to offset a rotation by individual investors, the JPMorgan strategists wrote. The biggest investment-grade bond buyers, including pension funds and insurance companies, are generally not big buyers of stocks because of risk management and regulatory concerns, they said.
"We do not believe a shift of funds from high-grade credit to equity is underway, or is likely," according to the report.
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