NEW YORK - The $3.4 trillion U.S. corporate bond market may bounce back next year from levels not seen since the last recession if the Federal Reserve Board lowers interest rates to keep the record expansion on track.
Corporate bonds lagged other debt this year - and the lowest-rated securities turned in their worst performance in at least 13 years.
A slowing economy, rising defaults, and profit shortfalls at companies from Xerox Corp. to E-Toys Inc. curbed investors' appetite for company debt and prompted banks to tighten their lending standards. Borrowers, bankers, and buyers are now looking to the Fed to cut interest rates so the economy does not stall. Until that happens, observers say, a major recovery is unlikely.
It "may be a comeback year, but it's not going to start with a big bang," said Marwan Marshi, head of U.S. fixed-income capital markets at Salomon Smith Barney, the Citigroup Inc. unit that led underwriters of investment-grade corporate bonds this year.
Against an improving backdrop, Mr. Marshi said, first-quarter sales of investment-grades could be $30 billion to $40 billion, less than half the total in the same period this year.
As 2000 comes to an end, banks and investors are demanding almost 2.25 percentage points more yield than benchmark Treasuries to lend to investment grade companies. The investors are demanding yields of more than 9 points higher than government debt to lend to junk-rated firms, according to Merrill Lynch & Co. That is the highest spread since the economic slump of 1990 to 1991.
While investment grade bonds returned more than 9% this year, including price gains and interest, that paled beside the 20%-plus gains from 30-year Treasuries and more than 11% return for mortgage bonds, according to Merrill research.
Bonds with the lowest credit ratings handed investors losses of more than 5% for the year, their worst performance since 1987, when Merrill first compiled data on returns.
Companies sold $297 billion of investment grade bonds so far this year, about 7% more than last year, according to Thomson Financial Securities Data. The tally was boosted by offerings from Deutsche Telekom AG, British Telecommunications PLC, Worldcom Inc., and other telecommunications companies that raised money to complete, expand, and make acquisitions.
The increase in sales came even as widening yield spreads raised borrowing costs. Deteriorating performance led to credit-rating cuts that drove firms such as Xerox and Conseco Inc. to junk status from investment grade status.
In the junk bond market, companies have sold $42.7 billion of new bonds this year, less than half last year's total and about 70% lower than 1998 levels, according to Thomson Financial. Rising borrowing costs and losses in junk bonds pushed the average yield above 14%.