US corporate bond market sees rise in both supply and demand
In recent months, there has been a
substantial increase in the supply of corporate bonds as well as increased
investor demand to hold such bonds. Here is what is happening:
First, many US companies have chosen to
frontload borrowing ahead of the election. Bond issuance in the US is 40% ahead
of the same period last year. In the first three months of this year, the
volume of bond issuance was 40% of last year’s annual total. One
possible explanation is that many companies are worried that, as the election
grows closer, there could be a rise in borrowing costs related to perceived
political risk. Another explanation
is that risk spreads are currently historically low. Thus, although government
bond yields remain elevated compared to a few years ago, corporate bond yields
are low compared to government borrowing costs. Investors might be betting that
low spreads will not endure. If so, now is a good time to borrow.
Second, there is a bull market in corporate
bonds as investor purchases of such bonds have soared. Thus, as companies
rapidly issue bonds, they are having no trouble finding buyers. One explanation for investor interest is that
they expect the Fed to cut interest rates later this year, leading to lower
bond yields. Thus, investors seek to lock in high yields. Moreover, if yields decline, that means that
valuations will rise. Meanwhile, the surge in demand for bonds has resulted in
a decline in risk spreads. For example,
the spread between the yields on Treasury bonds and high yield (junk) bonds is
now at the lowest level in three years. In addition, the spread between yields
on BBB-rated bonds and those of A-rates bonds is near a record low. This
pattern, in turn, is fuelling interest in issuance of bonds.
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Eurozone inflation continues to recede
The European Union (EU) has released data
on inflation in the 20-member eurozone and it was good news. In March, consumer
prices were up 2.4% from a year earlier, the lowest since November 2023. Prices
were up 0.8% from the previous month. When
volatile food and energy prices are excluded, core prices were up 2.9% from a
year earlier, the lowest since February 2022. On the other hand, core prices
were up 1.1% from the previous month.
As has been true for several months, the
lion’s share of inflation is in the realm of services. Prices of non-energy goods
were up only 1.1% from a year earlier. Prices of energy were down 1.8% while
prices of food were up 2.7%. Yet prices of services were up 4.0% from a year
earlier, the same as in each of the last five months. In other words, service
price inflation has stalled at an elevated level. The problem with services is
that they are labour-intensive. Moreover, Europe’s labour market remains
relatively tight with wages continuing to rise at a brisk pace. So long as this
is true, and so long as wage gains are not being offset by productivity gains,
inflation is expected to be sticky. Thus, the European Central Bank (ECB) is
keen to see the labour market weaken so as to suppress wage inflation. That is
why it is currently holding interest rates at a high level. On the other hand,
the ECB recognizes that the eurozone economy is weak. Thus, further tight
monetary policy risks pushing the economy into recession. For the ECB, this is
a balancing act.
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continuing its downward trajectory, the imperative for robust financial
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economic uncertainties. As inflationary pressures persist, individuals and businesses
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climate of resilience and stability in the face of economic challenges.
Currently, the conventional wisdom among
investors is that the ECB will wait at least until June before cutting interest
rates. By June, it will probably want to see evidence that wage pressure is
easing. If not, it might choose to wait longer before cutting rates. Meanwhile,
perhaps the most worrying aspect of today’s inflation report was the very big
month to month increase in prices. If this persists, it will lead to an
acceleration in annual inflation. The
hope is that this is simply a one-off event and will not be repeated.
By country, inflation varied in March. From
a year earlier, prices were up 2.3% in Germany, 2.4% in France, 1.3% in Italy,
3.2% in Spain, 3.1% in the Netherlands, 3.8% in Belgium, 1.7% in Ireland, and
3.4% in Greece. Keep in mind that these numbers are based on a harmonized
method of measuring inflation across the eurozone. Numbers reported by
individual countries might be slightly different due to differing methods of
measuring inflation. Meanwhile, the EU also released data on the labour market.
In the eurozone, the unemployment rate in March was 6.5%, the same as in every
month since November. Thus, the labour market has stabilized at a relatively low
level of unemployment. In fact, with the exception of November 2023, the
unemployment rate has been 6.5% in every month since March 2023. Moreover, this
is the lowest unemployment rate for the region since records began in
1995. By country, the unemployment rate
in March was 3.2% in Germany, 7.4% in France, 7.5% in Italy, 11.5% in Spain,
3.7% in the Netherlands, 5.5% in Belgium, 4.2% in Ireland, and 11.0% in Greece.
