High-Grade Bond Investors Are Betting on Duration

Investors are increasingly willing to buy longer-term bonds, locking in higher interest payments for years in a bet that the Federal Reserve is nearing the end of its interest-rate hiking cycle.

(Bloomberg) — Investors are increasingly willing to buy longer-term bonds, locking in higher interest payments for years in a bet that the Federal Reserve is nearing the end of its interest-rate hiking cycle.

Yields on longer-dated debt are so high that even if the Fed continues hiking for longer — as some expect after August’s hotter-than-anticipated consumer price index reading — investors still feel they’ll be compensated. The lack of long-duration offerings this year has created a scarcity premium on such debt.

“Although the rate environment has hurt returns, these moves have pushed the average all-in yield for 25y+ debt to 5.8%, making investment grade debt an increasingly attractive investment opportunity for yield-focused buyers,” wrote Barclays Plc strategists in a Sept. 8 note.

Borrowers are taking advantage of this, with 30-year offerings from the likes of T-Mobile US Inc., Nevada Power Co. and Sierra Pacific Power Co. seeing outsized demand from US buyers. In Europe, almost a fifth of September issuance was longer than 10 years and also attracted strong investor interest, data compiled by Bloomberg shows. A 12-year tranche, the longest of a four-part deal from Germany’s Sartorius AG, drew the biggest order book across European corporate tranches in September at eight times the size of the notes.

T-Mobile declined to comment. Nevada Power, Sierra Pacific Power and Sartorius didn’t respond to requests for comment.

Spreads on the 10-year-plus part of the curve tightened about two basis points to 137 basis points this month, while the overall US corporate investment-grade index is one basis point wider, at 119 basis points, implying stronger relative demand for long-dated debt even as bond prices have broadly been falling.

Strong demand from investors to lock in higher yields for longer and the “natural bid for longer duration” from insurance and pension investors has been driving the outperformance of longer-maturity bonds, said Travis King, head of US investment-grade corporates at Voya Investment Management.

“At the same time, we’ve seen less supply of long investment-grade as issuers have the opposite view and don’t want to lock in higher coupons for 30-plus-years,” he said. “So, it’s purely a technical-driven trade right now.” 

Spreads at the long end of the curve could face further pressure due to dealers’ relatively low holdings of the securities, which carry high risk of price moves as yields change. “As buyers continue to show interest in debt with long maturity, this lack of inventory should push spreads tighter,” the Barclays strategists led by Dominique Toublan wrote.

Inventories in the front-end and belly hover around the 50% mark of the one-year range, whereas inventories of 10-year-plus debt have sunk to 8%, according to Barclays.

“On a spread basis, 30-year bonds don’t look that attractive versus the spread on 10-year bonds,” said Voya’s King, noting that the 10s30s credit curve is toward the tighter end of the historical range. “But given the strong technical, 30-year may still outperform for some time,” he said. “So, we think longer-dated bonds remain attractive at this point and can continue to outperform.”

In the event of an economic slowdown, “you also have the duration exposure,” points out Arvind Narayanan, co-head of investment-grade credit at Vanguard Group Inc. In that situation, the bonds would help “drive positive total returns in a market that is likely to have negative total returns on the equity side.”

The recent wave of shorter-dated debt should bring down the average duration of high-grade bonds, making them less sensitive to interest rates, added Narayanan. “When you take a step back and look at the landscape over a longer horizon, we do believe that high-quality fixed income is very attractive right now,” he said.

“Longer-dated securities have a favorable technical, as well as offering the duration opportunity given forward curves,” said David Knutson, senior investment director at Schroder Investment Management. “An investor could earn stock-like returns on longer duration if market rate expectations are realized.”

Duration Grab

Last week saw more than $110 billion of bonds sold globally — the busiest start to September on record — with much of it skewed to debt due in less than 10 years. The deluge came as issuers tried to beat any market volatility arising from key inflation data releases on Wednesday and Thursday and the Fed’s two-day rate decision meeting that concludes on Sept. 20. 

Looking ahead, Barclays says that issuance will likely taper off after the September rush and that yields are unlikely to rise much more, making longer-dated bonds a good bet. “Given that curves have flattened even in times of increased new issuance, the expectation for diminished supply this September, especially in the long end, should only create more tailwinds for long-dated credit,” the bank’s strategists wrote.

Barclays recommends swapping out of 10-year bonds and into 30-year bonds, highlighting corporates with single A ratings like confectioners Mars Inc. and Hershey Co., oil producer ConocoPhillips and chipmaker Advanced Micro Devices Inc. as ideal candidates. Among its BBB rated picks are eBay Inc., Starbucks Corp., jam and jelly maker J.M. Smucker Co. and software maker Oracle Corp. 

However, not everyone is completely sold on the attractiveness of longer-dated maturities. Companies aren’t always eager to issue longer-term debt, locking in high interest payments for a long time. That’s especially true if they plan to refinance at lower rates in the near future, CreditSights Inc. analysts led by Global Head of Strategy Winnie Cisar wrote in a Sept. 11 note. 

“There is at some point the reality that you can’t just have an entirely front-loaded maturity stack,” Cisar said in an interview. “And so, borrowers are trying to figure out what is the right level of stomaching these higher yields.”

–With assistance from Finbarr Flynn, Brian Smith, Dan Wilchins and Michael Gambale.

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