Not a taper tantrum but something

Properly used, Corporate Bond ratings are effective tools helping marketing participants to understand risk and return. Simply put, as riskier assets will have lower ratings, and must provide an increase return to investors to entice them to purchase the assets. In other words, “the higher the risk the higher the return”.

The chart above two series, both provided by BofA Merrill Lynch. The black line (BAMLC0A1CAAAEY) tracks the yield of AAA rated corporate debt, while the blue line (BAMLC0A2CAAEY) tracks the yield of AA rated corporate debt. Each series is captured daily for the period September 6th 2012 to September 6th 2013.

On the left side of the chart you’ll see the expected relationship; AA rated debt (blue line) yield more then AAA rated debt (black line); all good. However on the right hand side the relationship is clearly violated, with AAA rated debt yielding more than AA debt. The table below shows both Moody’s and S&P ratings for a variety of borrowers. What’s going on?

Bloomberg offered a fairly detailed explanation, with one analyst suggesting “Investors have been grabbing credit risk over interest rate risk, so there’s more desire for lower credits and a little bit less desire for the AAA credits,”

Forbes suggested the difference in yields reflected little more than a difference in average maturities; i.e., AAA bonds (in their study at least) had a longer maturity and thus reflected higher risk to investors capital. Specifically, “At present, the average AAA has 13.63 years to go before it matures,versus 8.92 for the average AA. The difference, 4.71 years, is unusually large. “

A couple of cogent explanations for a genuine anomaly. Of course I’d suggest that Federal Reserve participation in the debt markets – currently purchasing $85B a month but likely to be reduced – is having an unpredictable effect.

Watch out for taper tantrums in the market as The Fed withdraws.

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