1/31/13

The other day, I had the opportunity to attend a presentation by an analyst who's focus is in Rates Trading. During the presentation, he talked about the future outlook of US Tsys and what that said about the US Government's future relating to its credit rating and debt/gdp ratio.

The most disturbing and eye opining chart was an overlap with the US Tsy yields and the AVERAGE AAA Corp yields, with the X-axis extending 30 years. Naturally, the AAA yields were a little higher than the Tsys...until year 25, where they intersected. Thus, year 30 showed that the AAA yields were lower than those of US Tsys (suggesting AAA Corps carry less risk in the long run).

Obviously, the implications are huge. This essentially means that there is greater confidence in AAA corporations making coupon payments than the US Government (startin in 25 years).

Another implication relates to how bonds are traded in a Risk-Off environment. Currently, the flow results in buying Tsys and selling Corps/Equities. If Corps become safer (lower yields) that could lead to a shift of inflowing Corps and outflowing Tsys. While only certain Corps are trading lower at this time, that number will likely increase as US debt obligations increase.

So do you guys (UGs, S&T Analysts, anyone) think that Risk-Off trading will see this dramatic shift, with Corps being the safer option?

"Presidents come and go; Exxon doesn't come and go." - Former ExxonMobil CEO Lee Raymond

Comments (11)

1/30/13

Corps are trading tight as shit because they are about the only place you can find yield without heading down towards junk bonds. The implication really isn't that people think a coporation is a better bet that the us government there is just no rational reason right now to be piling into the inflated values of treasuries unless you have to. Again, just moving out the risk curve which means moving into lower and lower quality higher yielding credit.

http://www.jasonbondpicks.com
In reply to Addinator
1/31/13

Addinator:
Corps are trading tight as shit because they are about the only place you can find yield without heading down towards junk bonds. The implication really isn't that people think a coporation is a better bet that the us government there is just no rational reason right now to be piling into the inflated values of treasuries unless you have to. Again, just moving out the risk curve which means moving into lower and lower quality higher yielding credit.

Although it's true that corps are trading tight because of the search for yield, that wouldn't help explain why Corp 30s were had a negative T-spread.

There are only four AAA-rated companies, so taking the "average" isn't really that meaningful. I'm speculating here, but there could be various aspects of the corporate bonds that make them more attractive than vanilla Treasuries (could have a put option, be convertible, etc.). Not confident that looking at the average yield on 30-year maturities of four companies really tells you much.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

1/31/13

If you think the AAA bond yield is scary, check out the low grade bond yield i think they are around 5.5% atm. Talk about investors starving for yields after 1+ year of cash outflow from equity market to fixed-income market.

In reply to NorthSider
1/31/13

NorthSider:
I'm speculating here, but there could be various aspects of the corporate bonds that make them more attractive than vanilla Treasuries (could have a put option, be convertible, etc.

Huh, I didn't think about that. I won't be able to check a BT until later today, but do you think that if they were vanilla corps that would be a significant indicator? Full disclosure, I am a UG which is why the negative T-spread appeared significant to me.

1/31/13

Bloomberg has stopped tracking their AAA Corp Composite, because there just aren't enough out there. All you have left are ADP, JNJ, XOM, and MSFT with that rating I don't think it's fair to look at that metric because of the options on most of the bonds. All of their longest bonds are callable before maturity, so the effective duration could end up being a lot shorter than that of a 30yr TSY. It could also be an income play because the longer Corps tend to pay a higher coupon than the 30yr TSY. So if you truly believe you will hold to maturity, probably only pensions and insurance companies, you will have more income to reinvest at a higher rate in the future (hopefully). Given that, these long duration bonds are probably not where you want to be, because if rates keep backing up you are going to get killed on total return. So as investors begin to sell LT corps to roll into shorter, less volatile corps, and the FED continues to buy LT TSY, keeping interest rates artificially low, I would think spreads will begin to widen. But back to JMR's point, it is insane that you have some corporates trading at a negative yield to TSY.

If nobody hates you, you're doing something wrong

In reply to TheSunAlwaysShines
1/31/13

daviscw12:
Bloomberg has stopped tracking their AAA Corp Composite, because there just aren't enough out there. All you have left are ADP, JNJ, XOM, and MSFT with that rating I don't think it's fair to look at that metric because of the options on most of the bonds. All of their longest bonds are callable before maturity, so the effective duration could end up being a lot shorter than that of a 30yr TSY. It could also be an income play because the longer Corps tend to pay a higher coupon than the 30yr TSY. So if you truly believe you will hold to maturity, probably only pensions and insurance companies, you will have more income to reinvest at a higher rate in the future (hopefully). Given that, these long duration bonds are probably not where you want to be, because if rates keep backing up you are going to get killed on total return. So as investors begin to sell LT corps to roll into shorter, less volatile corps, and the FED continues to buy LT TSY, keeping interest rates artificially low, I would think spreads will begin to widen. But back to JMR's point, it is insane that you have some corporates trading at a negative yield to TSY.

Good clarity here. I expected that this would be the case on the long-dated AAA corps. The fact that a 30-year benchmark yield has a negative T-spread probably misleading.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

In reply to jmr1991
1/31/13

jmr1991:
NorthSider:
I'm speculating here, but there could be various aspects of the corporate bonds that make them more attractive than vanilla Treasuries (could have a put option, be convertible, etc.

Huh, I didn't think about that. I won't be able to check a BT until later today, but do you think that if they were vanilla corps that would be a significant indicator? Full disclosure, I am a UG which is why the negative T-spread appeared significant to me.

It's hard to imagine it being a significant indicator to me.

There can be little doubt that AAA corps are not going to default (MSFT, for instance, has a $51 billion net cash position). In fact, I'd say the chances of MSFT defaulting on its debt is even lower than the chance of the Treasury defaulting on its 30-year maturities. The problem is that the currency in which all of that debt is denominated, and the currency on which a great deal of MSFT's cash flow is dependent is USD. In the event that the Treasury can't roll its long-dated maturities in the future and is forced to monetize, the devaulation of the USD would bring catastrophe to the real yield of AAA Corps.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

1/31/13

I don't think you should put too much fundamental reasoning in the long end of the curve. Spreads in that end is most likely dominated by issuance/supply anyway. Besides, the Fed is probably soaking up more than half of every new 30yr issue via OT2, making investors turn to corps, thus driving yields down.

In reply to msmandoo
1/31/13

msmandoo:
I don't think you should put too much fundamental reasoning in the long end of the curve. Spreads in that end is most likely dominated by issuance/supply anyway.

I agree with you here.

Besides, the Fed is probably soaking up more than half of every new 30yr issue via OT2, making investors turn to corps, thus driving yields down.

But this shouldn't cause AAA corps to have a negative T-spread. The Fed buying up 30yr issues should drive down the yield on 30s, but it doesn't make sense for investors to search for yield in 30yr corps if the yield is less than the 30yr Treasury.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

2/2/13

They aren't negative. The OAS for AAA long corporates is 88 bps as of market close today.
EDIT: Never mind, didn't see you specified 30 year bonds.
EDIT 2: All of the AAA corp bonds after 15 years have an OAS between 80 and 110 bps.

In reply to urmomgostocollege
2/2/13

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