Recent increases in both government yields and credit spreads have weakened the bond market in gener...
Recent increases in both government yields and credit spreads have weakened the bond market in general and corporate bonds in particular.
Worries over the strength of Western economies and the possible upwards impact on inflation have driven sovereign yields higher while oversupply has hiked credit spreads in the corporate market.
Rupert Pummell, credit analyst at M&G, says: "The sheer volume of supply in both Europe and the US, combined with reducing demand from retail investors due to the holiday season, has caused indigestion.
"Companies saw yields beginning to rise and so there was a panic to lock in issues at low yields. Year 2000 worries have also meant issues have been brought forward from the autumn. Unfortunately that has accelerated the end of the low yield period.
The recent issue by food manufacturer Premier International Brands was initially planned to have a yield of 11%. But as the market weakened it was widened to 12.25% to make the bond attractive to the market.
Pummell said that there had been several other deals where management had not been willing to boost yield and the bonds were never issued.
Another factor has been a widening in both US and UK swap spreads for the premium required to exchange a fixed rate income for a floating rate income or vice versa. These spreads are closely correlated to credit spreads.
Paul Causer, fund manager at Perpetual, says: "It's difficult to say why this is happening. Libor and bank Libor spreads don't indicate concerns about credit quality.
"The banks are perhaps trying to hedge positions on their balance sheets so there is a greater demand for fixed income which is pushing up swap spreads." According to Causer, the longer end of the UK corporate bond market has been more resilient than the shorter due to demand from life offices. Even so performance has been less than spectacular.
He says: "It is not really a good time for any bond market. Governments are in a corrective phase for most part reflecting the change in perception of fundamentals, such as inflation worries and central bank tightening, which is a global theme. This is not a good foundation for corporate bonds.
Causer has been buying government paper recently not corporates. He thinks that the US bear market might be reaching its tail and the market is being overly pessimistic. Nonetheless he is being careful.
He says: "We are fairly cautious with a view to soon take advantage of the value we see in the overdone situations in credit spreads. This is probably the story for the first quarter of next year but you have to be prepared.
Purchases will probably be made in the five to 10-year maturity sector as Causer sees no value in longer bonds. Here he thinks that the market is technically distorted because life offices seem to be buying long-dated gilts almost at any price to match long-term liabilities. This effect has also trickled over into the longer dated high quality corporate market.
Conversely, the much maligned high-yield bonds have been the best performers so far this year. Here the stronger-than-expected UK growth figures have boosted performance as it is more likely the issuer will be able to pay the coupon in a recovering economy.
However, at this end of the market, which is more closely correlated with the equity market than the bond market, picking sectors has been important.
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