More U.S. corporate bonds are paying negative inflation-adjusted yields, as expectations that interest rates will stay near historic lows send investors seeking higher payouts in riskier assets.
The ICE BofA U.S. corporate index for bonds maturing within five to seven years, for example, is paying negative real yields for the first time since 2013.
And bonds issued by Apple Inc. in August, maturing in 10 years, yielded only 1.16 per cent as of Wednesday, compared with expected inflation of 1.72 per cent a year over that time period.
Driving the moves are investors shifting into lower-rated debt expecting that the Federal Reserve will keep yields on short- and intermediate-term Treasuries at rock-bottom levels for years as it grapples with the economic fallout of the coronavirus pandemic. Bond yields move inversely to price.
That outlook was reinforced last week, when chair Jerome Powell said the Fed would allow periods of higher inflation before raising rates.
While the returns on shorter-dated corporate debt are at record lows – as measured by the ICE BofA one-three year U.S. corporate index – they still beat what investors can expect on Treasuries with similar maturities.
“When the Fed lowers its interest rates it really just kind of forces investors to take on risk,” said Eric Souza, senior portfolio manager at SVB Asset Management. “Investment grade credit and asset-backed securities is where you may start to pick up that positive net yield.”
Fed programs, including unprecedented Treasury and corporate bond purchases, and its commitment to holding rates near zero is seen as effectively providing a backstop for shorter-dated debt. But the low yields are also making it harder for investors to generate income.
The move into corporate debt is “exactly what the Fed had planned when they were pushing investors out the maturity and credit spectrum,” said Vishal Khanduja, director of investment grade fixed-income portfolio management and trading at Eaton Vance in Boston. “Go on, take more risk, because we are going to control the yield curve and the credit curve from here.”
Bond yields have also been weighed down by companies increasing their cash cushions and holding back from investing in higher-risk projects until the economy picks up.
“On the real economy side, the opportunities for investing in high returns are not really there,” said Robert Tipp, chief investment strategist at PGIM Fixed Income in Newark. “As a result, that liquid cash goes into the market where at least you can adjust if the world changes.”
The Fed’s commitment to letting inflation run higher before raising rates, meanwhile, has helped hold up inflation expectations, even if market participants remain doubtful that the U.S. central bank will hit its 2-per-cent target any time soon, having missed this goal for decades.
“Longer term though I still think the market’s anticipating a rather sluggish recovery and therefore somewhat benign inflationary pressures,” Gary Pollack, managing director fixed-income at Deutsche Bank Private Wealth Management in New York.
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