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Talking point
High-yield bonds in times of monetary normalisation:
Less speed, more grip
July 12, 2013
The recent Fed announcement may have marked the beginning of the end of monetary expansion in the
US. This note revisits previous research to distil some implications for high-yield corporate bonds. It
argues that monetary normalisation should be associated with a moderating effect on issuance volumes,
but also with a more investment-oriented usage of the money raised.
Until recently, debt markets were in a fairly unique spot: economies in Europe and the US were fragile and
underperforming, allowing central banks to provide ample liquidity by conventional and unconventional means.
Yields of benchmark government bonds were at record lows.
Nevertheless, recovery has started making some progress. The US economy has passed pre-crisis levels of GDP
lately and Europe will probably boast positive growth rates in the second half of this year. This trend has
supported a more optimistic outlook by investors and a growing risk appetite. Moreover, central banks in key
markets have made it very clear that they would go to great lengths to prevent a relapse into crisis using
unconventional measures if necessary.
Low interest rates on benchmark bonds and rising risk appetite
have encouraged investors to shop around for higher yields.
Corporate bonds have become a preferred investment option as
we described before (Kaya and Meyer, 2013a, 2013b). High-yield
products enjoy particular interest: the global volume of high-yield
bond issuance reached almost USD 280 bn in H1 2013, surpassing
pre-crisis peaks by significant margins particularly driven by
buoyant activity in the US.
Fed tapering sends shockwaves
The recent announcement of the Federal Reserve to slow and
eventually phase out asset purchases (tapering) sent shockwaves
across many risk markets. High-yield spreads widened and
issuance volumes of corporate bonds slumped initially as market
participants sought to adjust to the new trajectory.
This seems to be a good opportunity to revisit our previous findings
and focus on monetary influences. All in all, we identified three
main drivers which together appear to explain HY bond issuance volumes reasonably well. Statistically, they
explain 74% of the quarterly variation. Specifically we find the following drivers to be associated with stronger
issuance activity:
Falling high-yield spreads as a result of investor demand, issuing debt becomes cheaper
Tight bank lending standards borrowers tap the bond market as an alternative (see also Schildbach, 2013)
Expansionary monetary policy liquidity supply increases
Quantitative easing (QE), as illustrated by the size of the Feds balance sheet, is particularly interesting given
recent events. Empirical evidence suggests that QE has an important positive impact on HY bond issuance.
Moreover, according to the specifications used here, the size of the Fed balance sheet is statistically more
relevant than the growth rate of the balance sheet.
But context is important. QE is a fairly desperate measure used when conventional monetary policy has reached
its limits and/or monetary transmission, i.e. the translation of liquidity supply in actual economic activity, is failing.
Talking Point
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As a consequence, QE may be associated with a boom in issuance
but also with a shift in the usage of proceeds. Indeed, prior to the
financial crisis (pre-Lehman) on average 40% of the proceeds of
HY bond issuance in the US were used to refinance or repay old
debt, according to Dealogic. Ever since the beginning of the crisis
and the start of asset purchases by the Fed, the share of proceeds
used for refinancing has jumped to 53%. In other words: corporate
borrowers use a smaller share of the new money to expand their
business or to execute acquisitions. The translation of liquidity
supply into investments is thus weaker, diluting the overall
economic impact of quantitative easing.
To be sure, the quarterly time series of the use of proceeds is quite
volatile, allowing a number of interpretations. However, the
difference is statistically significant and robust to sizeable variations
in volatility before and after the crisis periods. Moreover, using
econometric models to control for other confounding factors
consistently identifies the size of the Fed balance sheet as being
economically and statistically relevant.
Monetary normalisation may slow issuance activity but increase economic grip
Given the empirical patterns described above, the path towards monetary normalisation may be associated with a
certain reversal of previous dynamics. Note, however, that all empirical experiences are based on periods when
balance sheets were expanding. The exit from QE is thus somewhat uncharted territory.
Two effects of monetary normalisation seem likely, however. Firstly, gradual tightening should have a moderating
effect on HY bond issuance volumes because liquidity will became scarcer and the opportunity costs of capital will
rise. Secondly, the idea to simply refinance old debt may lose appeal. The share of proceeds used to expand
businesses may thus increase. The high-yield bond market may lose speed but gain economic traction.
The key challenge for monetary authorities will be to set a course that is commensurate with the economic
outlook. Risk assets in general should benefit from a stronger economy arguably outweighing the impact from a
cut in liquidity supply. Too aggressive tightening, however, would weaken the recovery.

References
Kaya, Orcun and Thomas Meyer (2013a). Corporate bond issuance in Europe: Where do we stand and where are
we heading? EU Monitor. Global financial markets.
Kaya, Orcun and Thomas Meyer (2013b). Corporate bonds: Little support for EMUs periphery. Talking Point. 11
April 2013.
Schildbach, Jan (2013). Corporate funding in Europe: Bonds replacing loans? Chart in Focus. 11 June 2013.

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Orcun Kaya (+49) 69 910-31732

Thomas Meyer (+49) 69 910-46830
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