Bond Market On Track For Record Year!

 |  Includes: AGG, VZ
by: John M. Mason

Dealogic, a source of statistics on fixed income markets, indicates that the United States is "on track" to see corporate bond issuance in 2013 exceed the record it achieved in 2012. Last year, slightly more than $1.0 trillion of high-grade corporate bonds were issued in the United States. Through October 23, almost $885 billion of these issues had come to market. Yesterday, another $12 billion in bonds were placed.

Most analysts believe that longer-term interest rates will rise over through 2014. This certainly gives companies some incentive to raise a lot of financial capital.

The reality of this possibility has been captured in the increase in bond rates since last spring. The yield on the 10-year traded in the 1.65 percent to 1.75 percent range in the middle of April.

Soon after this time period, large amounts of money that had been invested in "safe haven" U.S. Treasury securities begin to return to Europe as confidence in the European financial system and European economic recovery began to grow. As a consequence of this flow, longer-term U.S. interest rates began to rise.

The yield on the 10-year Treasury peaked around 3.00 percent in early September. Interest rates began to modestly fall again as the liquidity of the bond market improved after the Federal Reserve announced that it would not begin to "taper" its monthly security purchases quite yet.

Adding to the bounce in bond prices was the government shutdown and battle over the debt ceiling. Perversely as it may seem, these actions have contributed to higher bond prices and lower interest rates because investors have assumed that the shutdown and debt ceiling battle will cause the economic growth to remain tepid for a longer period of time and this will cause the Fed to postpone any "tapering" into the winter months…or possibly even into spring.

Consequently, the yield on the 10-year Treasury bond has dropped into the 2.45 percent to 2.55 percent range. Analysts still believe that interest rates will go up next year…so, it is a good time to issue bonds!

Verizon Communications (NYSE:VZ) came to market in early September with an issue that was the largest one on record … $49 billion. The issue came out with the yield on the 10-year government bond around 2.90 percent, but the feeling at that time was that the yield on bonds would continue to rise because the economy seemed to be picking up steam and the Federal Reserve was thought to be serious about beginning "tapering" in the near future.

One might also add that the relationship between the yields on government bonds and Aaa-rated corporate bonds over the past two months was as narrow as it has been since October of 2008. Obviously, this makes it that much more attractive for corporations to issue bonds in a market this receptive.

The uses for the funds obtained in these debt issues. Mostly, the money seems to be going toward paying down other debt and other financial engineering. Some of it will go into physical investment, but only a minor portion.

There is plenty of money around, but it only seems to be circulating within the financial circuit of the economy. As a consequence, we get movements in the prices of financial assets but little or no bounce in economic activity. That's just the way it is these days.

My guess is that we will see the volume record broken this year for new high-grade corporate debt issues. I believe that this will also continue into 2014. The rush-to-market will even accelerate as longer-term interest rise through the year. The incentive is for those corporations that can, locking in lower interest rates on their debt is a good thing to do, even if the interest rates they end up paying seem high by today's standards.

This, of course, will mean that investors will be able to place higher yielding, high-grade corporate debt into their portfolios in 2014. The risk is that as interest rates proceed to higher levels … bond prices will decline. This is a tradeoff, however, that must be faced.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.