The great U.S. corporate bond issuance

Singularly, you may not have noticed various U.S. companies either re-finance existing debt or importantly issue new debt, over the past year or so.
Collectively, it is a monumental amount of debt.

Cleverly, these companies have taken advantage of the almost perpetual low yields of the government benchmarks, upon which they can base their spreads against.

Companies such as Oracle, Amazon & Goldman Sachs have issued bonds either secured or unsecured against their equity at historically low yields; which is brilliant financial strategy for these companies.

With interest rates at such low levels, probability and cycles suggest that rates will rise in the coming 6 years or so.

When 10 year benchmark rates are 6% and not 2%, I can’t see a 10 year 2.5% coupon Oracle Corp. bond being redeemed early, meaning bond holders will probably suffer capital losses unless held until maturity. Just imagine holding a bond that yields 2.5% into the latter half of this decade while others are earning twice or three times that amount?

Although, we are seeing a great bond issuance cycle, capital markets will most likely miss out on the next re-financing cycle.

What happens then?

Perhaps, companies will payout maturing debt by selling their own shares, which incidentally, they accumulated in share buy-backs conducted in 2012/2013 using the cheap money that they obtained from the same investors who bought their bonds?

Listen to the market – China’s inverted yield

The spread between the yield of Chinese Govn’t 2yr and 10yr bonds have inverted. The yield that an investor is receiving buying 2 year maturing debt is higher than the yield from a 10 year bond.

Although the data on the attached graph only starts in 2005, an inverted yield curve signals stress in the credit market and leads to weaker equity markets. It is often a good indicator that precedes recession or a change in economic cycles.

It is notable that United States 2’s/10’s spread inverted in 1978, 1988, 2000 & 2006. Recessions followed within 12-18 months.

The trade to look at, is for a falling Australian Dollar. With this comes a rising US Dollar and falling commodity prices.

An inverted Chinese bond yield could spell trouble for the most crowded of “longs” because not many believe BHP, RIO and the Australian Dollar can fall – for China will apparently keep saving them all.

It is highly likely that China will still buy their products, but there is such a thing as cycles and although China has seemed to have avoided one in the past 15 years, the optimism in this post is to be ready to buy some bargains in Australia, China along with some commodities.

In the meantime, selling AUD and buying USD is hardly the worst trade to consider.

source - Bloomberg

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