Major US bond investors have been aggressively shifting funds into long-term notes, wagering that this neglected asset class will benefit from eventual interest rate reductions. These investors, who often manage substantial portfolios, have started reallocating resources towards longer-dated securities in anticipation of a favorable interest rate environment. The expectation is that, as economic conditions evolve and central banks, particularly the Federal Reserve, move to cut interest rates, the value of these long-term bonds will rise, providing significant returns. This shift marks a strategic pivot from the short-term bonds that have been preferred in a high-rate environment, showcasing a nuanced understanding of the evolving economic landscape.
Research by JPMorgan Chase & Co. reveals that the top 20 US mutual fund managers have extended their duration over the past two months as yields have risen. This means they are now holding bonds that mature further in the future, which tend to be more sensitive to changes in interest rates. As yields climbed, these managers saw an opportunity to lock in higher returns before the anticipated rate cuts drive yields down again. Nikolaos Panigirtzoglou, a global market strategist at JPMorgan, explained that investors have been heavily investing in high-grade corporate bonds. These bonds, issued by financially stable companies, offer a balance of risk and return, making them an attractive alternative to government debt, which currently offers lower yields and can result in a negative carry, where the cost of holding the debt exceeds the income generated.
Long-term corporate bonds are regaining popularity among investors who had withdrawn as the market anticipated fewer immediate rate cuts by the Federal Reserve. Earlier, there was a widespread belief that the Federal Reserve would rapidly lower rates to stimulate the economy. However, as this expectation faded, many investors exited long-term bonds. Now, the appeal of these bonds is returning because recent economic data has shown a decline in US inflation for the first time in six months, leading markets to price in two rate cuts this year. This renewed interest indicates that investors are increasingly confident that the economic conditions will necessitate easing monetary policy, thereby boosting the attractiveness of long-term bonds.
"Historically, yields tend to rally strongly about three to four months before the Fed starts cutting rates," said Gershon Distenfeld of AllianceBernstein Holding LP, who recently extended the duration in the $23 billion American Income Portfolio he manages. Distenfeld's comment reflects a historical pattern where bond yields typically rise in the months leading up to the Federal Reserve’s rate cuts. By extending the duration of his portfolio, he positions his investments to benefit from this anticipated trend. He added that this rally could begin "in a month or two, six months from now, or not until 2025," acknowledging the uncertainty in the timing of the Fed's actions. This strategic move underscores the importance of timing in bond investing and reflects confidence in the eventual policy shift.
The "anything but bonds" trend may have peaked, and long-duration debt is likely to make a comeback in the second half of the year, Bank of America Corp. strategists wrote in a Friday note. This trend refers to the widespread investor preference for assets other than bonds, which prevailed as interest rates rose and bond prices fell. However, as the economic outlook shifts, these strategists believe that the appeal of long-term bonds is set to rise again. The anticipation of a more favorable interest rate environment in the latter part of the year is driving this change in sentiment. Investors who had previously avoided bonds are now reconsidering their positions, recognizing the potential for significant returns as interest rates decline.
According to a survey by the bank, fund managers increased their bond allocation by an average of 7 percentage points from April, though they remain overall underweight. This indicates a substantial increase in their commitment to bonds, reflecting a growing confidence in the asset class. However, despite this increase, bonds still constitute a smaller portion of their portfolios compared to historical norms, indicating a cautious approach. Conversely, cash levels dropped to their lowest in nearly three years, suggesting that managers are moving away from holding cash towards investing in bonds. This shift from cash to bonds highlights a strategic reallocation in anticipation of future market conditions.
In response to the demand for long-term debt, healthcare company Merck & Co. Inc. offered a 30-year bond this week, the longest-dated euro corporate bond since 2021. This move aligns with corporate strategies to capitalize on current market conditions. By issuing long-term debt, companies like Merck can secure financing at favorable rates, lockingin borrowing costs for an extended period. This strategy is particularly advantageous as rates on long-term European debt are currently lower than short-term credit rates, enabling companies to finance their operations more cheaply over the long term. This issuance meets the growing investor demand for longer-duration assets, providing a win-win scenario for both the issuer and the investors.
“Companies are taking advantage of the low prevailing credit spreads and locking in that risk premium for their borrowings,” said Luca Bottiglione, head of European credit research at Zurich Insurance Group AG. Bottiglione's statement highlights how companies are strategically issuing debt in the current market to benefit from low credit spreads. By locking in these favorable conditions, companies can secure a stable and predictable cost of borrowing, which is advantageous for long-term financial planning. The low credit spreads reflect the perceived low risk of corporate debt relative to government debt, making this an opportune time for companies to issue long-term bonds.
Merck's deal increased the average maturity of corporate bonds issued in the region’s publicly-syndicated debt market this month to about 7.6 years — the highest since October 2021, based on data compiled by Bloomberg. This increase in the average maturity of corporate bonds indicates a significant shift towards longer-term financing. The data, which includes euro, pound, and dollar sales in the region and excludes perpetual and hybrid notes, shows that companies are increasingly opting for long-term debt. This trend reflects a strategic response to current market conditions, where longer-term debt offers a balance of lower interest rates and extended financing periods, benefiting both issuers and investors.
“Corporations might be finding a sweet spot in the markets right now,” said Althea Spinozzi, head of fixed income research at Saxo Bank AS. “They can secure the lowest yields on the yield curve, while many investors, eager to bet on an aggressive rate-cutting cycle, are willing to extend duration.” Spinozzi's observation underscores the advantageous position corporations find themselves in. They can issue long-term bonds at low yields, reducing their cost of capital. Simultaneously, investors are willing to extend the duration of their holdings in anticipation of rate cuts, which would increase the value of these bonds. This confluence of factors creates a favorable environment for both issuers and investors in the long-duration debt market.
19.05.2024
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