MBS MID-DAY: Bonds Bounce Back as Corporate Issuance is a No-Show

Apparently, issuers of corporate debt thought it would be best to get it out of the way early this week--perhaps with an eye on the mid-week holiday and uncertain rate environment.  That resulted in a hefty dose of new debt supply yesterday from multiple issuers.  By comparison, today isn't even in the same league, with just one new issuer stepping up to the plate.

Why does all this esoteric stuff matter?

It's not too terribly esoteric when we break it down to its simplest components.  Here's a handy step-by-step list of why we sometimes care about what's going on with corporate bond issuance:

1. Corporate bonds are bonds
2. Some investors may choose corporate bonds over other securities (like Treasuries or MBS)
3. When more corporations issue debt, there is a greater supply of corporate debt.
4. Remember corporate bonds are bonds, so #3 also means there's a greater supply of debt/bonds in general
5. Higher supply = lower prices = higher yields

That's the "supply" piece of the corporate debt equation.  The other piece is where things actual do get a bit esoteric.  It has to do with how corporations hedge their issuance.  "Hedge" is just a needlessly confusing word for "offsetting risk."  Corporations enlist the aid of financial firms to handle the issuance process, and they expect those firms to protect a certain interest rate that the corporation will soon be required to pay.  These firms (referred to as "Book-runners") are functionally equivalent to a secondary marketing desk trying to keep their pipeline 'optimal' (no risk, and no reward for market movements in either direction).  

The bookrunners can account for the risk of rate fluctuations by selling Treasuries or making trades that have the same effect.  If rates move lower, the company will benefit from paying out a lower rate to investors when it finally issues bonds.  If rates move higher, the company will make money on its Treasury hedge/sale (because Treasuries are the basis for corporate bond pricing).  And yes, these hedges can often be bought back if profitable--meaning that bonds can bounce back if they've taken a hit from corporate issuance.

All that to say, yesterday saw more corporate issuance, which hurt bond markets.  Today is seeing much less, which is helping us catch a break.  Of course that's not the only factor, but it's one of the most readily apparent.  We could also simply be witnessing the first plateau in this leg of the selling spree.  We cautiously began to entertain that possibility yesterday, and today keeps the hope alive so far.  The "caution" part has to do with the fact that we often see 1-3 days of a pause amid a broader negative trend, and must not be too quick to assume it marks the end of the negative trend.