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Speculation Powers Recent Rallies by Corporate Bonds

Investors have a lot of confidence in the remedial powers of stimulus

Excerpts from Moody’s Analytics, authored by John Lonski, Chief Economist, Moody’s Capital Markets Research, Inc. Access the full report at www.moodys.com.

Thus far in April, earnings-sensitive financial markets have improved despite what is likely to be a wretched month for both U.S. business activity and the labor market. Apparently, investors have a great deal of confidence in the remedial powers of mass injections of monetary and fiscal stimulus.

In addition, market participants sense a gradual lifting of restrictions on business activity beginning in May. Lately, markets have not been pricing in a prolonged outage of business activity in response to COVID-19’s threat to public health.

Consider the course of Moody’s Analytics’ long-term Baa industrial company bond yield. After forming a high at the 5.60% of March 23 and ending March at 4.86%, the long-term Baa industrial yield has since eased to April 15’s 4.22%. After falling from a March 20 high of 418 basis points to March 31’s 354 bp, the long-term Baa industrial company bond yield spread has since narrowed to April 15’s 295 bp.

Though April 15’s 295 bp spread is wider than its 193 bp average of the five years ended 2019, of greater importance for corporate borrowing costs is how the accompanying 4.22% long-term Baa industrial yield is well under its 4.74% average of the five-years-ended 2019. By contrast, the average 8.83% long-term Baa industrial company bond yield of October 2008 through March 2009 was substantially above its 6.51% average of the five-years-ended 2007.

The yield for all US-dollar denominated Baa-grade corporate bonds contained in the Bloomberg/Barclays index concurs with the current trend of MA’s long-term Baa-industrial yield. Barclays Baa bond yield has declined from a March 23 high of 5.43% and March 31’s 4.24% to April 15’s 3.38%, where the latter was noticeably less than its 3.78% average of the five-years-ended 2019.

Forecasters now grapple with unprecedented uncertainties. Never before have the dispersions of projections been so wide. For now, consensus forecasts hardly constitute anything resembling a consensus...

After having dropped from a March 20 high of 4.58% to March 31’s 3.43%, the Bloomberg/Barclays yield for U.S.-dollar denominated investment-grade corporate bonds subsequently fell to April 15’s 2.75%. The latter is less than its 3.39% average of the five-years-ended 2019. The situation was far worse during October 2008 through March 2009, or when the span’s 7.93% average for the investment-grade bond yield was far above its 5.18% average of the five-years-ended 2007.

Despite how early April’s Blue-Chip consensus forecast of a 4.1% annual decline by 2020’s U.S. real GDP is deeper than the cumulative 2.7% drop from 2007 to 2009, thus far, the high-yield bond market has held up much better compared to the most difficult stretch of the Great Recession.

Never Before Have Forecasts Been So Far Apart

Forecasters now grapple with unprecedented uncertainties. Never before have the dispersions of projections been so wide. For now, consensus forecasts hardly constitute anything resembling a consensus. The now unrivaled gap between high and low forecasts warns investors to be prepared for the unexpected.

Consider the Blue-Chip consensus, or average, prediction of a 24.5% annualized sequential contraction by second-quarter 2020’s real GDP. This average was bounded by an unheard of 24 percentage point gap between a -37% average for the 10 lowest forecasts and a -13% average for the 10 highest projections. The Blue Chip consensus calls for a 4.1% annual drop by calendar-year 2020’s real GDP. However, the projection is bounded by a very wide gap of 8.5 percentage points between the -7.4% average for the 10 lowest forecasts and a -1.1% average for the 10 highest forecasts.

Ordinarily, the more distant the forecast, the wider is the dispersion between the low and high forecasts. However, partly because economists rightly or wrongly implicitly assume a material containment of COVID-19 risks, the consensus prediction of a 3.8% rise by 2021’s real GDP is bounded by a narrower 4.9-point gap between the averages of the lowest and highest ten projections of 1.5% and 6.4%, respectively.

Read the full report, Speculation Powers Recent Rallies by Corporate Bonds, from Moody’s.