A recent NYT article points out the latest trend in US corporate strategy – issuing tons of bonds at record low interest rates. In essence, since corporate bonds are pegged to the US 10 Year Treasury (albeit, usually at a slight premium depending on relative safety of the issuer), with the 10 Year at historic lows at or below 2% on any given day, US corporations are issuing loads of debt at never before seen lows. Some recent transactions:
- Macy’s – $550 million of 10-year bonds at 3.87%; $250 million in 30-year bonds at 5.125%
- Citigroup – $2.5 billion in five-year bonds at 4.48%
- Advance Auto Parts – $300 million in 10-year bonds at 4.5%
…and the list goes on. Some companies have even been going so far as to issue 100 year bonds at low rates. If their hurdle rate is in the teens and they have investment opportunities, why not leverage up and increase profits in the coming years? It seems like a sound strategy which can turn into a self-fulfilling prophecy. As corporate profits continue to improve as a result of these record low borrowing rates, the likelihood of default decreases, ratings improve, rates commanded drop even lower and bond prices increase further. While that may sound good in concept, the other big wildcard is what happens to US Treasuries and inflation.
Presently, the Fed is indicating that rates won’t increase until well into 2014. However, if the economy does improve faster than anticipated, the Fed will be under intense pressure to increase rates more quickly. That would have an adverse influence on all fixed income investments, corporate bonds included. So, time will tell. Investors seeking higher yield now should consider junk bond ETFs for both improved yield and diversification while noting that a decline in the economy could cause volatility in this ETF much greater than high grade corporates.