The bond market has a yield problem, with over $11 trillion in high-quality debt currently trading with a negative effective yield.
This means investors mandated to hold the debt of nations and corporations that are least likely to miss payments are in many cases paying for the privilege of getting a regular coupon.
Enter the US corporate bond market.
Currently, investment-grade US corporate debt accounts for just 12% of international high-quality debt outstanding but is responsible for about a third of the total yield.
Here’s how Bank of America’s Hanks Mikkelsen lays it out in a note to clients on Thursday (emphasis mine):
“Consider the $49tr global investment grade broad market consisting of sovereign, quasi-government, corporate, securitized and collateralized debt. While the $5.9tr US IG corporate bond market represents only 12% of that global market, it is now responsible for 33.0% of its total (effective) yield payment. In other words, nearly one in three (global) dollars paid out in the global IG broad market is paid to investors in the US IG corporate bond market.”
The only game in town for getting something back on your money, then, is US corporations.
Here’s the stunning chart from BAML:
And with the European Central Bank buying up corporate bonds — and concerns swirling that the ECB could run out of stuff to buy — US corporate debt, in Mikkelsen’s view, is likely to remain attractive for investors that are starved for yield.
Here’s Mikkelsen again (emphasis, again, mine):
“Our belief in the willingness and ability of foreign central banks to ease and force foreign investors to reach for yield in the US corporate bond has never been greater. As such we expect to remain bullish US HG corporate credit until foreign growth picks up and the monetary policy stances of foreign central banks change. That could mean we are bullish for the remainder of the year and well into 2017, as it appears that foreign growth is declining — not increasing. Case in point Brexit is expected to push the UK into recession and shave a half percentage point off economic growth in the remainder of the EU, as well as a couple of tenths elsewhere. That is furthermore expected to lead the Bank of England (BoE) to cut rates and embark on doing QE this summer. Due to the resulting decline in interest rates the ECB could be forced to reach for yield further into peripheral debt as opposed to core. We also expect the Bank of Japan (BoJ) and other foreign central banks to ease. When foreign central banks ease foreign investors have only one place to go — the US corporate bond market.”
Mohamed El-Erian’s latest book “The Only Game in Town” argued that in a post-crisis world where fiscal austerity and loose monetary policy has reigned supreme, central banks have become the “only game in town” when it comes to providing help for slow-growing economies.
But this is an idea that is difficult to visualise.
Mikkelsen’s chart, however, gives us a clear illustration of what happens when markets get distorted and investors are truly left with just one game to play.
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