US government debt may have lost its AAA rating, but its spreads have tightened over the past week as markets begin to digest the downgrade. A move that should give some corporates cause for concern and others cause for optimism.
It is paradoxical, but it’s true. Although US Treasury bonds have become more ‘risky’, investors have ploughed their cash into them. In an investment environment in which the downgrade has only helped to introduce extra volatility, US Treasuries are still seen as a relative safe haven.
As a result, the yield on US two-year notes recently fell to a record low of 0.228%, while the yield on benchmark 10-year notes reached 2.325%, a low not seen since January 2009. This has spelled bad news for sub-investment grade corporate debt issuance, with investors opting to unwind their positions in ‘junk’ bonds after the downgrade.
On Monday, junk debt prices fell sharply after light trading. The secondary markets witnessed some selling, but there was a distinct lack of interest among buyers, except at discounted levels.
Investment grade debt, on the other hand, has for the most part continued to trade robustly over the period. It did experience an initial wobble on the markets immediately after the downgrade. Indeed, the additional yield that investors were demanding to hold US investment-grade corporate debt rather than Treasuries jumped 16 basis points to 190 basis points, the highest since September 2010.
That proved nothing more than a blip, however. Investors have since continued to seek out extra yield among those high investment-grade corporates which have maintained their balance sheets and their credit ratings during the financial downturn and the aftermath of the downgrade.
The buying spree is somewhat surprising, given that the average yield on the Barclays Capital index of US investment-grade corporate bonds last week reached an all-time low of 3.42%, but the circumstances are quite unique. All this suggests that now is a good time for corporates with ratings of BBB or above to tap the US debt capital markets and to lock in very low coupons.