In the past few months, along with various market news and changes in the Federal Reserve's policy outlook, US treasury bond bonds have experienced a roller coaster trend.
The yield of 10-year US Treasury bonds has continued to fluctuate significantly, rising to over 5% in October last year, then dropping to nearly 3.75% in December last year, and slightly rebounding to 3.94% last week. The ICE BofA MOVE index, which measures the volatility of interest rate swaps, is over 50% higher than the 10-year average this month.
Market insiders predict that with the Federal Reserve cutting interest rates by at least 0.75 percentage points in 2024, as well as strong employment, sticky inflation, and uncertain prospects brought about by the global election year, there will be more volatility in US interest rates in the future. "For the bond market, this is a very confusing and dangerous moment," Viner Bhansali, founder of LongTail Alpha LLC and former PIMCO executive, warned earlier this month. He predicts that in the coming months, the 10-year US Treasury yield will continue to fluctuate back and forth between 3.65% and 5%.
Meanwhile, US investment grade corporate bonds have started the year strongly. According to data compiled by the media, as of January 12th, US companies have issued approximately $100 billion in new bonds. The market expects the total bond issuance in January to reach 160 billion US dollars, exceeding the 144 billion US dollars in January last year and recording the largest January issuance scale since 2017.
In this context, the six major bond underwriters on Wall Street - Bank of America, JPMorgan Chase, Goldman Sachs, HSBC, Mizuho Financial Group, and Mitsubishi UFJ - have all found a significant increase in the demand for US companies to use bond hedging tools to reduce interest rate risk and lock in some borrowing costs in advance before bond issuance in response to soaring interest rate fluctuations. Industry insiders say that this indicates that US companies hope to protect themselves from sudden interest rate shocks in the face of uncertain future financing costs, especially when already held bonds are about to mature or there are short-term merger and acquisition plans.
Amy Yan, Joint Head of Global Interest Rate and Monetary Solutions at Bank of America, said, "With interest rate levels recently accompanied by a significant decrease in expectations of the Federal Reserve's interest rate cuts, corporate finance executives with financing needs in 2024 and beyond are using tools to lock in the current lower cost of issuing bonds."
In fact, this pre issuance hedging and hedging tool is not a new tool. American companies have been using this tool to lock in and hedge some financing costs for decades, but they have become increasingly popular recently. This tool can take multiple forms. One of them is T-lock, that is, the enterprise and the bond underwriting bank have reached a comprehensive agreement that allows the issuer to basically lock in the benchmark US treasury bond bond interest rate. Some companies also use so-called Collar strategies to hedge the volatility of bond base prices and protect potential downside risks. If interest rates rise, this strategy can limit the downside space of corporate bonds, but similarly, to hedge against downside risks, this strategy also limits potential profits, meaning that if interest rates fall, the upside space of bonds is also limited.
In addition, US companies can also use derivatives such as forward starting swaps or swap options to gain more certainty about future financing costs. Compared to hedging short-term or several month bonds, these derivative products can better help businesses hedge bond risks for two years or more. Underwriting banks typically charge fees based on the degree to which the company locks in or hedges the risk and the duration of the bond issuance.
Reid Hamilton, Head of Americas Corporate Risk Solutions at HSBC, said that some companies believe that the bond market (from lows before last year) has rebounded excessively. Recently, the decline in US bond yields has led companies to seek protection against further increases in yields. However, this protection comes at a cost, as underwriting banks will charge corresponding fees for these derivatives, and if interest rates further decrease, related companies may find themselves in trouble.
However, most of the time, businesses will profit from this. Safehold Inc., headquartered in New York and specializing in leasing business, has chosen to provide long-term interest rate hedging guarantees for the upcoming issuance of $400 million new bonds. "Although these hedges are intended to provide protection for our bond issuance, they can also be realized at any time," said Brett Asnas, the company's CFO, during a earnings conference call. "For example, when we want to refinance existing bonds that are about to mature with long-term debt, we will lift the hedge and attach the proceeds to the bonds, effectively reducing the financing interest rate we pay."
In addition to regular bond issuance, underwriting banks have revealed that some companies planning to finance mergers and acquisitions through borrowing are also seeking hedging and locking in more attractive financing costs.
Shiv Vassiht, co head of global interest rate and currency solutions at Bank of America, predicts that "as companies increasingly seek to hedge interest rate risks shortly after signing merger and acquisition agreements to protect the economic viability of the underlying agreements, the proportion of M&A financing demand in bond offsetting demand will continue to soar."
Ewut Steenbergen, Chief Financial Officer of S&P Global, stated that the cost of the $750 million corporate bond issued by the agency in September last year has been lowered by 75 basis points due to corporate hedging against interest rate risk. Most of the funds raised in this financing have been used for acquisition, and there are still some remaining funds. The company plans to refinance it in 2025. "Although the current interest rates are still high, as long as we have the opportunity to use hedging and lock-in measures, we can still refinance in an attractive way."