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US corporate bonds signal beginning of credit thaw
By Dena Aubin
NEW YORK, Dec 17 (Reuters) - U.S. corporate bonds are staging an unexpected rally in the final days of the year as interest rates of close to zero on risk-free assets send investors into higher-yielding bonds.
Spurring the latest improvement was Tuesday's historic cut in interest rates by the Federal Reserve and a pledge by the central bank to use all tools available to promote growth.
"These extraordinary efforts by the Fed to steady the economy, to thaw out financial markets might finally be working," said John Lonski, chief economist at Moody's Investors Service.
Battling a year-long recession, the Fed on Tuesday cut benchmark interest rates to as low as zero. It also signaled a willingness to buy potentially huge amounts of debt in an unconventional move to drive down private borrowing costs. For details click on [ID:nLH516622].
High borrowing costs have been a massive weight on economic growth, choking off business spending and worsening a cash crunch at the weakest companies.
HIGH-QUALITY SPREADS NARROW
"The Fed's statement was very reassuring - that we're going to keep rates where they have to be for a considerable amount of time," said Matthew Freund, who manages about $2 billion of fixed-income investments at USAA in San Antonio.
Also important is the Fed's stance of "quantitative easing," or the use of its balance sheet to buy up securities and promote lending, he said. "They're really not targeting a rate as much as just saying we're going to let our balance sheet do what it needs to do," said Freund.
Corporate bond yields, relative to those on Treasuries, remain near record highs, a sign that risk aversion has not disappeared. But spreads have narrowed in recent days, especially on the highest quality corporate bonds.
Spreads on double-A-rated corporate bonds have tightened to 494 basis points over Treasuries, down from a high of 515 basis points on Nov. 21, according to Merrill Lynch data.
Another boost comes from more strategists recommending at least a modest dip into corporate bonds.
"They are already trading at spread levels close to highs reached in the Great Depression and would likely lead any market rally," Barclays Capital said in a research report on Wednesday.
Borrowing rates remain extraordinarily high for many U.S. companies, but on average they have declined nearly a full percentage point over the past six weeks as a flight to quality pushed rates lower on benchmark Treasury bonds.
Corporate bonds overall now yield 8.25 percent, versus 9.22 percent at the end of October, according to Merrill Lynch.
Those yields still look tempting to investors, especially as rates on Treasuries and other low-risk securities drift close to nil.
FED ENCOURAGING RISK
"One of the things the Fed had done is make it very, very difficult to own risk-free assets," said USAA's Freund. When the flight to quality runs its course, "folks are going to ask, do I really want to own a 10-year Treasury yielding 2 percent - is there something better I should do?"
Until recently, the corporate new issue market was dominated by financial issues sold under an FDIC debt guarantee program. Month-to-date, about $58.8 billion of FDIC-backed debt had been sold, versus about $17.5 billion of straight corporate bonds, according to Thomson Reuters data.
In a sign of improving risk appetite, there is now more demand for nonfinancial bond sales, even from the lower-quality range of investment-grade borrowers.
Kraft Foods (KFT.N: Quote, Profile, Research, Stock Buzz), a "triple-B" rated issuer, on Tuesday attracted about $4 billion in demand for $500 million of five-year notes, according to IFR, a Thomson Reuters publication. Kinder Morgan Energy Partners (KMP.N: Quote, Profile,Research, Stock Buzz), another "triple-B" borrower, attracted more than $2 billion in demand for a $500 million offering, IFR said.
More nonfinancial issuers are jumping in before the markets close for year end. Safeway Inc (SWY.N: Quote, Profile, Research, Stock Buzz), another "triple-B" issuer, sold $500 million of five-year notes on Wednesday while Walt Disney Co(DIS.N: Quote, Profile, Research, Stock Buzz) was marketing $1 billion of five-year notes, according to IFR. (Reporting by Dena Aubin, Editing by Chizu Nomiyama) (dena.aubin@thomsonreuters.com; +1-646-223-6325; Reuters Messaging: dena.aubin.reuters.com@reuters.net))
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