[NASDAQ] Why U.S. Corporate Borrowing is Surging Ahead of an Anticipated Economic Recovery
It has recently been reported that U.S. companies have been leaning heavily towards purchasing bonds with a fixed coupon rate. Since last year, the rate of issuance of these fixed rate bonds has risen 12%, while floating rate bonds have dropped an even more dramatic 33%. The reason for this lies in how borrowers expect the economy to respond as the world moves beyond the covid pandemic and begins to see some recovery. This is a trend we’re expecting to see until well into 2022, and here’s why.
With the onset of the global crisis, the U.S. Federal Reserve pushed down interest rates to just 0.25%, and has recently confirmed their intent to keep rates at this level until inflation rises above 2%. The intent has been to encourage borrowing and by extension spending, which should help in expanding the economy at a time when it is needed the most.
This has proven to be a helpful move, but now the world is showing, perhaps, the first signs that the end of the pandemic may be in sight. Vaccines are beginning to roll out and in the U.S. a $1.9 trillion stimulus package was recently passed, with goals to increase national employment over the next year. This is highly likely to be what is pushing investors towards bonds that have a fixed rate as opposed to variable rates. If this stimulus package is successful then it should facilitate increased employment. As employment goes up it will also increase circulation of money and by extension, inflation. Eventually, the Fed will be forced to raise interest rates again to offset this inflation, which will of course affect the profitability of any bond whose rate is floating.
Not only does this just make sense economically, but there is actually a second layer of reasoning for investors to get involved with fixed rate bonds bonds right now. You see, it only stands to logic that fixed rates are the most profitable when applied to high yield bonds, and generally the highest yields come from high-risk companies.
However, thanks to stimulus programs like the Paycheck Protection Program (PPP), small businesses have additional safety nets underneath them. This, to some degree, offsets the inherent risks with these types of bonds. Combining this with fixed low-interest rates for at least several months makes this investment opportunity notably more attractive.
It is plausible that as we approach 2022 we will see the aforementioned rise in inflation and this opportunity will come to an end. Being able to predict this shift is certainly fueling investment in these products, but there is a chance it won’t end as soon as predicted. For one, if further surges in Covid activity continue to harm the U.S. economy, then the existing stimulus package may prove to still be insufficient.
There is another way inflation, and hence interest rates, could stay low. Though unlikely before 2022, if the Fed offered aid in the form of a new, government-backed, Central Bank Digital Currency, it could potentially limit the effects of inflation on the current dollar supply. This would be assuming that the new asset would be unique and separate, even if it is still recognized as currency. In this case, it may be possible to continue a near-zero interest rate without pushing up inflation too much. This all being said, the US is currently still very much in the research phase for CBDCs, so this very well may not pan out at all.
In any event, it is clear that anticipation of economic recovery is one of the main forces driving the trend towards fixed-rate bonds. Even if it takes longer than expected for interest rates to rise, these bonds should still be solid investments. However, the fact that on average businesses are betting that there will be a recovery soon is an optimistic outlook for the economy as a whole.
Originally published at: https://www.nasdaq.com/articles/why-u.s.-corporate-borrowing-is-surging-ahead-of-an-anticipated-economic-recovery-2021-03
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