CORPORATE BONDS TAKE A BEATING AS INTEREST RATES RISE

From 1 October 2021 through 9 November this year, an index following investment-grade corporate bond prices lost about 20 percent of its value, The Wall Street Journal reported.

The index reflects the optimistic view of bond prices.

According to some measures, bond prices have lost more than during any year dating back to 1926.

The yield on bonds issued by companies with strong financials is about 6 percent, roughly double what it was a year ago.

Less well-off corporations and small businesses will have to offer a distinctly higher interest rate to borrow money, the WSJ said.

Although corporate bankruptcies and defaults remain relatively few, more corporations are showing signs of financial stress, the WSJ noted.

The manufacturing, real estate, and retail industries are seeing sales decline as rising interest rates have left fewer people able or willing to afford pricey purchases. 

Carvana, the online car dealer, is exemplary of corporations’ worsening plight.

The company’s sales shrank 8 percent in this year’s third quarter, while the size of its interest payments tripled as interest rates climbed higher.

Bonds Carvana issued this year to survive the pinch had to fetch a 10.25-percent return to lure buyers. The bonds currently trade at less than half their face value.

During the COVID War, while money was still cheap, corporations borrowed heavily. Higher-risk firms sold a record number of new bonds in their attempts to survive the crisis. 

However, higher interest rates have choked off any new, affordable sources of funding for companies most desperate for new loans at a time when analysts are predicting either feeble growth or a full-blown recession next year.

Rating agency Moody’s foresees “adverse” borrowing conditions through June 2023, with more companies defaulting as the U.S. Federal Reserve continues raising interest rates amid inflating prices and softer spending by businesses and consumers.

In Moody’s “moderately pessimistic scenario,” defaults among all but top-rated corporations will climb to 7.9 percent by next September, compared to 2.3 percent in September this year.

In what perhaps is a harbinger, Revlon went bankrupt in June after failing to meet payments on $3.8 billion in debt. Bed Bath & Beyond owes $1 billion, is closing stores and cutting staff, and recently announced a deal with creditors in which debt is being transformed into shares of stock.

The Federal Reserve Bank of New York’s Corporate Bond Market Distress Index has reached its highest level since late 2020, excluding a blip early in the COVID War.

As troubled companies stumble or fail, borrowing costs for well-fixed companies also could rise as investors begin to wonder how far the damage will reach, the WSJ noted.

“It can have a cascading effect,” Joe Quinlan, Bank of America’s chief market strategist, said to the WSJ. “The herd gets moving in one direction and that can create its own problems.” 

TREND FORECAST:  As we noted in “Will Junk Bonds Turn to Junk?” (14 Sep 2021), junk bonds were in trouble as soon as the Fed laid out a timetable for ending its bond-buying spree and raising interest rates.

The rate of corporations defaulting on bonds will increase every time the Fed raises its benchmark interest rate.

Even if the Fed pauses its campaign of rate hikes, defaults will continue to rise: only speculators will want to bet on overborrowed companies floundering in a weak economy.

This is the case not only in the U.S., as we pointed out in “Global Junk Bond Markets Reeling” (1 Feb 2022), junk bonds are in trouble around the world. Their rising rates of default, especially among developing nations, will speed the world’s fall into recession.