Demand for corporate debt remains robust as the spread between private sector issuance and U.S. Treasury bonds has modestly narrowed to 150 basis points.
Despite a large increase in private sector paper linked to the artificial intelligence buildout, public issuance of debt does not appear to be crowding out private sector financial needs.
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Issuance
The investment community continues to show its appetite for corporate bonds. Since the 2022 inflation spike, corporate issuance has increased at a 16% yearly rate, while trading volume has grown by nearly 14% per year.
Part of this dynamic is the increased interest in convertible bond issuance, which gives investors the opportunity to transfer their investment into equity in the company and to share in its growth.
The demand for yield
The demand for higher yields became more pronounced during the pandemic era of near-zero interest rates.
The continuation of the demand is evident in the co-movement of so-called investment grade corporate bond yields with risk-free Treasury bonds.
While Treasury bonds have range traded between 4% and 4.5% over the past few years, corporates have traded roughly 165 basis higher.
The risk premium for holding a corporate bond has been dropping and recently fell briefly below 150 basis points before the restart of the Mideast hostilities.
Robust demand
Demand for corporate and government securities remains robust. We do not see any meaningful competition for scarce capital from public and private sources crowding out demand.
Yet, that will not endure indefinitely.
The large tech companies have recently pivoted from revenue-financed expansion to tapping public debt markets.
The broad and deep American capital markets have absorbed that demand and the economy is doing quite well because of it.
But with the hyperscalers continuing to spend, one does not have to look too hard to see an upside risk to interest rates.
Eventually, the government’s deficit-financed spending will lead to lenders charging a rising risk premium to both public and private sources of demand.
The takeaway
Demand for yield remains healthy enough to support increased issuance of corporate bonds and to narrow the interest-rate spread relative to risk-free Treasury bonds.
We expect the demand for yield to continue as the capital markets finance the next phase of technological advancements.
Still, there is no excuse for complacency around what is a historic buildout to support the structural transformation of the economy. At some point, the rivers of capital financing private and government debt issuance will flow less freely.
