Falling US corporate bond sales are one of debt's few positives

New York

TOP-RATED US corporations are expected to sell less debt next year, a bright spot for a high-grade market that faces a wide array of risks in 2022 as the lower supply coupled with strong demand can help sustain valuations.

Most of the biggest banks are forecasting that sales will be down about 5-10 per cent from 2021's US$1.4 trillion, meaning the money that keeps pouring into the corporate bond market will have fewer new securities to buy. That could help keep risk premiums which are already low by historical standards stay about where they are, according to fund managers and syndicate professionals.

Falling issuance and strong demand will likely counter the impact of the risks remaining in the nearly US$7 trillion market, such as the pandemic flaring up further and interest rates jumping. Rising bond yields could hit corporate bonds particularly hard, because their price sensitivity to these moves is close to all-time highs.

"Technicals will probably overwhelm any kind of volatility that we see," said Todd Mahoney, head of US debt capital markets at UBS Group AG. "We expect consistent inflows, supply down, and a pretty good year for redemptions. When you put all those things together, it should be enough to hold spreads in pretty well."

Strategists at Bank of America and Barclays also expect spreads to stay range bound next year, not straying far from where they currently stand. The average spread now is just under 1 percentage point, according to Bloomberg index data.

Bond sales are being met with demand that remains relatively strong. Investors have been pouring money into high-grade corporate bond funds, adding cash to them in 43 out of 50 weeks this year, according to data from Refinitiv Lipper. They are often looking for higher yield than Treasuries. Central banks worldwide are taking steps to cut down on the liquidity sloshing around the financial system, with the Federal Reserve forecasting a series of interest-rate hikes over the coming years that include 3 in 2022.

But even that could entice more foreign investors, an important source of demand this year, to buy corporate bonds in 2022.

"Even if rates back up 50 or 100 basis points, they're still going to be attractive on both a nominal and real basis," said Marc Fratepietro, co-head of global investment grade debt capital markets at Deutsche Bank. "You have the balance sheet firepower, you have the low cost of capital, and you have companies that want to do M&A (mergers and acquisitions). That will drive activity in our market next year."

On top of that, investment-grade company balance sheets look exceptionally strong, with low leverage and high cash levels compared with historical norms. That puts companies in a strong position to weather any potential slowdown to the economy next year.

"Companies are in really good shape," said Matt Brill, head of North America investment-grade at US$1.6 trillion asset manager Invesco. "Even if the economy were to slow down with the Fed hiking progressively, we think corporations are in much better shape to handle it. I'm pretty optimistic we should be at least range bound for spreads in 2022."

JPMorgan Chase thinks the bonds could do better than just stay in their current range - it sees spreads heading towards all-time tights. Above-trend economic growth, higher Treasury yields that will stoke demand, and the expectation for lower supply are all positives for bond spreads, strategists led by Eric Beinstein wrote.

Not every strategist is as optimistic about the near term. Deutsche Bank strategists are calling for significant widening of as much as 30-40 basis points in the first half of the year. Even so, they also see a second half recovery that will bring spreads toward current levels.

More of the bonds that companies do sell next year will likely be linked to acquisitions. Deutsche Bank said there are about US$140-145 billion of bonds funding M&As that it can now see for 2022, more than double the level this time last year.

Other banks are also expecting more debt linked to acquisitions. Many investment-grade companies also have high cash levels that they might look to use to buy other corporations.

With inflation running at the hottest pace in decades, the Fed will begin the year by weaning markets off of the exceptionally loose monetary policy they have grown accustomed to over the last decade. Central bank policy may be the biggest risk for credit markets next year, investors say. If rate hikes accelerate past what has already been communicated in order to fight inflation, significant losses could be in store for longer-duration high-grade credit which is most sensitive to rising yields. BLOOMBERG