By Dena Aubin
NEW YORK, June 11 (Reuters) - U.S. corporate bond yields this week have hit their highest levels since 2002 as inflation worries push rates higher on benchmark Treasury debt.
Average yields on investment-grade corporate bonds closed at 6.32 percent on Tuesday -- the highest since July 30, 2002, when they hit 6.36 percent, according to Merrill Lynch (MER.N: Quote,Profile, Research) data.
Treasury yields surged on the view that the Federal Reserve would raise interest rates later this year to combat inflation pressures. Safe-haven buying lowered Treasury yields modestly on Wednesday, but not enough to offset recent rate climbs.
Investment-grade corporate bond yields have risen by about 40 basis points over the past month, meaning it costs an additional $400,000 in annual interest for every $100 million borrowed.
The climbing yields are adding to economic uncertainty and "on balance this is not going to be good for corporate bond issuance," said John Lonski, chief economist for Moody's Investors Service.
"It might sideline some companies if they believe that the rise by Treasury bond yields, and in turn by investment-grade bond yields, is fundamentally unwarranted," he said.
"There may be some companies that believe yields will decline quickly enough once it becomes apparent that U.S. growth remains very much subpar," he said.
Companies will often rush debt sales to market if they expect a sustained climb in borrowing rates. But instead, investment-grade corporate bond issuance has slumped to just $16 billion in the month-to-date, down from $63.5 billion in the same period in May, according to Thomson Reuters data.
May saw a record volume of supply, with over $141 billion priced, on the heels of a near-record $117 billion in April.
If issuers are now delaying offerings until the interest rate outlook becomes clear, "that would suggest there's some doubt whether or not underlying the U.S. economy is robust enough to shoulder the latest climb by bond yields," Lonski added.
Inflation concerns were ratcheted up last week after Federal Reserve Chairman Ben Bernanke said rising longer-term inflation expectations were a "significant concern" for the central bank.
Short-dated Treasury yields had their biggest one-day jump in 25 years on Monday, reflecting higher implied prospects for a Fed rate hike in the fourth quarter to thwart inflation.
Lonski said he expects yields to decline, with the 10-year Treasury remaining in a range of about 3.75 percent to 4 percent. Ten-year Treasury yields fell by about 6 basis points on Wednesday to 4.04 percent.
Investment-grade corporate bond sales will likely slow from the torrid pace of April and May but still end the year 9 percent higher than 2007, or about $854 billion, Lonski said.
Much of the past two months' supply came from financial companies bolstering balance sheets, and that will likely continue, Lonski said. Companies also need to refinance short-term debt and outstanding bonds, he said.
A resurgence in risk appetite after the rescue of Bear Stearns (BSC.N:Quote, Profile, Research) had helped bolster demand for corporate bonds in April and May, but investors' appetite has been quenched somewhat by the heavy supply, said Robert Bishop, portfolio manager for SCM Advisors in San Francisco.
Although average yields are rising, new issues are not as attractive because issuers are not paying the generous yield concessions they did in the spring.
Much of the April and May supply came from financial companies bolstering balance sheets after massive write-downs, and they were willing to pay up because they needed the money, Bishop said.
"A lot of deals that came when the market first reopened were just too good to pass up," Bishop said. "Even if you weren't really looking for credit, if you were a total return manager there were some awfully good opportunities, and that's just not the case any more." (Reporting by Dena Aubin; editing by Gary Crosse)
