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Wall Street still prefers bonds

Investors' return on U.S. corporate bonds has been falling since its August peak, but buying has only accelerated, especially in investment grade bonds that are offering historically low yields.

The state of play: Since hitting its 2020 high on Aug. 4, the benchmark Bloomberg Barclays U.S. bond aggregate has delivered a -2.2% return. (For comparison, the S&P 500 has gained 3.9% during the same time period.)

  • However, investors have gobbled up bond mutual funds and ETFs. In September alone bond funds saw $50 billion of inflows, and drew $45 billion of inflows in the first two weeks of October, according to data from the Investment Company Institute.

What we're hearing: "Since the COVID-19-related meltdown, corporate investment-grade debt funds have attracted net new money each week since the fund-flows week ended April 15, 2020," Tom Roseen, head of research services at Refinitiv Lipper, tells Axios.

  • "They do appear to be on track to replicate, if not beat, the net inflows from 2019."
  • "2020 looks like it will be another banner year for the group."
  • Refinitiv's data show investment grade bond funds and ETFs have drawn $168 billion of inflows this year.

The backdrop: Bonds have been highly sought after for years as older populations near retirement and the stock market had continued to rise, outpacing fundamentals and creating a historically long bull market that had investors expecting a crash.

  • Then central banks slashed interest rates around the globe in response to the coronavirus pandemic, pushing investors out of government debt and into corporate bonds to generate yield.

What's next: Companies are poised to deliver significantly less debt in 2021, says Hans Mikkelsen, credit strategist at Bank of America Securities.

  • He's expecting investment grade companies to issue between $800 billion and $1 trillion, the midpoint of which would be the lowest since 2011.
  • He expects net issuance in 2021 to be around $326 billion, the second lowest since at least 2002, as fewer companies will need cash after 2020's record debt binge.

"We've never seen anything like this before, where companies have done so much refinancing in one year and also built this cushion of $360 billion in cash," Mikkelsen tells Axios.

  • That will create an unprecedented "artificial shortage," he adds. "It's a bullish environment for spreads."

Yes, but: Bond issuance was expected to slow dramatically in Q3 as companies moved further away from the March selloff, but instead IG companies issued more than $267 billion of bonds, and high-yield companies sold more than $119 billion, per Dealogic.

  • Both were the largest amounts for a third quarter on record dating back to 1995.
Data: Investment Company Institute; Chart: Axios Visuals

More than 35% of the world's government debt and 25% of all global debt now has a negative yield and we're edging closer to the record highs seen in August 2019, Deutsche Bank multi-asset research strategist Jim Reid notes.

  • That includes around $1.1 trillion of negative-yielding corporate bonds.

Why it matters: The incredibly low level of yields and central banks' pledges to continue quantitative easing and low-interest-rate policies for years means there will be consistent appetite for corporate bonds. That means it's sensible for companies to consistently hold higher levels of debt, BofA's Mikkelsen says.

  • "If you open up your old corporate finance textbooks it makes sense that companies have more debt in their capital structures when it’s cheaper."
  • "It may be that 30 years ago that the optimal rating for an investment grade company was A, but now maybe it’s BBB."
  • "We wouldn’t want it to be another way because then GDP would be lower."
Data:; Chart: Axios Visuals

The value of bonds is falling because yields keep rising on higher inflation expectations.

What happened: U.S. Treasury yields rose to their highest level in four months on Wednesday as investors continue to price in a blue wave Democratic sweep that is expected to drive trillions of dollars more in fiscal spending from Washington over the next few years.

  • Benchmark 10-year note yields rose to 0.84%, the highest since June 9, and the yield curve between 2-year and 10-year notes steepened to 68 basis points, the widest since June 8.
  • Yields on the 10-year note have jumped 15 basis points since Oct. 1.

What it means: Increased government spending is expected to raise inflation, which boosts the yield and reduces the value of already-held bonds.

  • Both Morgan Stanley and Goldman Sachs have said in recent notes to clients that a blue wave could push the Fed to raise interest rates sooner than expected — but "sooner" means in 2023 or 2024, rather than 2024 or 2025.

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