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Interest Rate Cuts Spark Renewed Interest in Long-term Corporate Bonds

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Leo Gonzalez

May 18, 2024 - 19:31 pm

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Mounting Optimism for Interest Rate Cuts Fuels Resurgence in Long-dated Bonds

In a notable pivot, prominent investors in the United States have been channeling considerable amounts of capital into long-term securities, acting on the anticipation that these often-overlooked assets could substantially benefit from prospective reductions in interest rates.

Big Money Bets on Duration

Market trends have revealed a strategic emphasis on long-dated notes as the top 20 mutual fund managers in the US have decisively lengthened their portfolios' duration over the recent months in response to increasing yields, as pointed out by JPMorgan Chase & Co.'s research. In an attempt to sidestep the unfavorable implications associated with government debt, these investors have shown a preference for high-quality corporate bonds, noted Nikolaos Panigirtzoglou, a JPMorgan global market strategist.

Revived Allure for Corporate Bonds

Long-duration corporate bonds have started to attract investors who initially retreated from the market due to scaled-back expectations of immediate policy easing by the Federal Reserve. However, following reports indicating a retreat in US inflation for the first occasion in half a year, optimism is renewed. Markets are now factoring in the possibility of two rate cuts within the current year.

Gershon Distenfeld from AllianceBernstein Holding LP, who has recently opted to extend the duration in the $23 billion American Income Portfolio he oversees, said that it is common to witness a rally in yields as the Fed approaches rate cuts. This phenomena could materialize sometime soon or be as far off as 2025.

Strategists at Bank of America Corp. suggested in their recent memo that the tide might be changing for long-duration debt, predicting a rebound in the second half of the fiscal year after a phase they described as the "anything but bonds trade."

Furthermore, according to Bank of America's survey, fund managers have raised their bond allocations by an average of 7 percentage points since April, although they still maintain an underweight stance in general. In stark contrast, cash levels have dwindled to their lowest in nearly three years, signaling a shift in investment strategies.

Corporate Response to Market Demand

In direct response to this investment shift, some corporations have begun offering bonds with extended maturities. One such example is health care giant Merck & Co. Inc., which has issued a 30-year security, marking the longest-dated euro corporate bond since 2021. Corporations are benefiting from the current market conditions, locking in lower rates for longer terms since longer-term European debt rates fall below those of short-term credit, as explained by Luca Bottiglione, head of European credit research at Zurich Insurance Group AG.

This strategy has resulted in the average tenor of corporate bonds issued in the region's publicly-syndicated debt market reaching approximately 7.6 years for this month— the most extensive since October 2021, as per the data compiled by Bloomberg. This dataset encompasses euro, pound, and dollar transactions in the area and excludes perpetual and hybrid notes.

Althea Spinozzi, Saxo Bank AS's head of fixed income research, commented on the favorable environment that corporations currently encounter. They can benefit from the lowest yields along the yield curve while catering to a significant investor base that is eager to bank on an aggressive rate-cutting cycle, willing to extend duration.

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Leveraged Finance Sees a Surge

The landscape of leveraged finance seems to be tilting back towards a seller's market, with implications that could include a revival in asset sales. Among investors, the appetite for risk seems to have risen to the extent where risk management has taken a back seat.

Some investors are veering towards purchasing debt from the lowest-rated countries, earning such risky gambles the moniker "special situations" on desks dedicated to emerging markets around the globe. The popularity of such bets is currently on the upswing, a trend that does not seem to be abating anytime soon.

Further shaping the corporate bond market, the expansion of electronic trading and the escalating popularity of portfolio trading has had an unexpected outcome: it has made private credit all the more appealing.

Within Europe, the hunger for bonds sourced from collateralized loan obligations is bolstering the earliest of rate-cut gains for the bloc's most precarious companies. These businesses are looking to cement their earnings before the banks make moves to slash rates, which could happen as early as the upcoming month.

An Abundance of ABS Market Activity

There's been a surge of activity in the asset-backed securities market recently, leading to the most significant number of bonds sold this year. Companies are hastening to borrow before inflation reports introduce new levels of uncertainty to financial markets.

Financial institutions such as Citizens Financial Group Inc. have turned to previously out-of-favor categories of preferred shares, which are now experiencing a renaissance among regional banks in the US.

On the international stage, default events have made headlines, with Agile Group Holdings Ltd., a Chinese property developer, facing public dollar bond defaults for the first time – a stark indicator of the persistent hardships within the nation's exceptional real estate crisis.

In contrast, Merck & Co. Inc brought to Europe's corporate bond market the longest-dated offering in the common currency since 2021, which may soon stand as a rare opportunity for investors to secure appealing yields before central banks commence rate reductions.

Seeking to diversify their currency exposure, McDonald's Corp. released Canadian dollar bonds for the first time since 2017. They've joined a string of US corporations that are leveraging the Canadian borrowing market.

Luxury car manufacturer Ferrari NV also played a notable part in the recent financial maneuvers, managing to significantly diminish their funding costs in the course of a scarce bond issue.

A substantial portion of approximately $900 million in a direct loan for Depot Connect International's refinancing efforts is being supplied by giants such as Blackstone Inc. and Goldman Sachs Asset Management, illustrating a move away from more expensive private debt.

On a separate note, Peloton Interactive Inc. has appointed JPMorgan Chase & Co. to organize a loan sale worth nearly $850 million, intended to refinance preexisting debts.

Banks, including Barclays Plc, Deutsche Bank AG, and UniCredit SpA, are orchestrating over €800 million (equivalent to $870 million) in debt financing. This effort backs up the bid by TDR Capital for the Italian discount retailer Acqua & Sapone, showcasing the fluid movements of capital in international markets.

Executives on the Move

Adding to the churn in the financial sector, there is a flurry of notable appointments. Fortress Investment Group has enlisted former Goldman Sachs Group Inc. managing director Michel Dimitri, aiming to enhance their private credit division. Mr. Dimitri will report directly to Andy Frank, a key figure leading global sponsor finance.

Another heavyweight, Apollo Global Management, has wooed Chris Adair to take the role of managing director and fixed-income specialist. Previously a part of SLC Management, where he served as a senior managing director and head of strategic partnerships, Mr. Adair's move signifies the continued reshaping of expertise within the industry.

Furthermore, private credit firm Brinley Partners, with over $4 billion assets under management, has welcomed Rex Chung aboard. Mr. Chung transitions from his prior role as a partner at Hunter Point Capital, further illustrating the dynamic landscape of recruitment within the sector.

The investment paradigm shifts and strategic moves among corporate treasurers and global fund managers highlight the intriguing dance of capital across different asset classes as the financial markets continue to evolve. It also underscores the ever-present nature of risk-taking and adaptation strategies amidst economic uncertainties.

Accompanied by assistance from financial industry experts like Brian Smith, Cecile Gutscher, James Crombie, and Helene Durand, these developments provide a clear snapshot into the world of finance as it adapts to an ever-changing economic landscape.

For more detailed insights into these market shifts, readers can access the wealth of financial analysis offered by Bloomberg L.P., a premier source for financial data and news.

©2024 Bloomberg L.P. All rights reserved. This documentation and any accompanying analysis are provided for informational purposes only and should not be construed as investment advice.