When an investment banker wants you to do a deal, he or she wants you to do it right away — their annual bonus may depend on it. The timing reflexively promoted by Wall Street junk bond underwriters last year happened to be perfect, though. High-yield bond sales hit record levels with global issuance topping $500bn. Yields and spreads plumbed lows thanks to implicit and explicit support from the Federal Reserve.
On Wednesday, however, the 10-year US Treasury jumped back above 1 per cent, a threshold last reached in March. With Democrats poised to control Washington, expansive fiscal policy has reignited inflation concerns. The second half of 2020 may enter the record books as the peak of a decades-long bull market for bonds.
At the end of 2020, the spread on the ICE BofA corporate bond index had fallen to just one per cent. This when unemployment remained historically elevated and the pandemic continued unabated. Even low-rated unsecured junk bonds were selling on yields of just five per cent.
For companies, particularly those in the troubled travel and hospitality sectors that loaded up on cheap cash, 2020 and 2021 may have provided the best possible scenario for a terrible pandemic. As the economic and health crisis eases later this year, profits will pick up, enabling them to avoid distress. And with inflation finally apparent, they will repay obligations in dollars that have become less valuable.
Rock-bottom interest rates powered by a central bank backstop drove up valuations of all risk assets in 2020. What next? Will higher interest rates coupled with a strong economy keep equities afloat? Or will inflation hedges such as gold and bitcoin be the main beneficiaries? Either way, brave investors have a hedge in leveraged loans which pay floating interest rates.
Of course, a 10-year Treasury at 1 per cent, 1.5 per cent or even 2 per cent is still historically low. This underscores the conditions in the debt markets in 2020 that may never recur. Some believe propping up zombie companies — those whose operating profits cannot service debts — is a perversely inefficient allocation of capital. The counter argument is that companies got low-cost lifelines, avoiding expensive bankruptcies. Jobs were saved. Those bankers earned their bonuses even if buyside investors are nursing modest paper losses today.
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