–1% Rise in Eur Corp Bond Spread Means Lesser Rise In U.S. Spreads

By Steven K. Beckner

(MNI) – The European sovereign debt crisis has widened corporate
bond spreads in Europe, and a good part of that widening has been
transmitted to the U.S. corporate bond market, research at the San
Francisco Federal Reserve Bank released Monday shows.

The San Francisco Fed economists find a “less than one-to-one”
transmission of European corporate bond spreads to U.S. corporate bond
spreads, but the impact on U.S. spreads is bigger for lower-rated bond
issuers and for financial corporations.

A widening of a one percentage point in the spread between European
corporate bonds and government bonds leads to a widening of the spread
between U.S. corporate bonds and U.S. Treasury bonds ranging from 0.44
to 0.85 percentage points, according to Galina Hale, Elliot Marks and
Fernanda Nechio of the San Francisco Fed research staff.

Because U.S. Treasury securities are widely viewed as a “safe
haven,” capital fleeing the euro-zone’s troubles have pushed up Treasury
prices and lowered their yields dramatically relative to European
government bond yields. But corporate bond yields have not fallen in
line with Treasury yields.

The three economists observe that corporate bond spreads in the
United States and Europe tend to “move together” because of close trade
ties and cross-country bank lending.

When U.S. Treasury yields fall, U.S. corporate bond yields do not
fall as much, just as European corporate bond yields trade higher than
government bond yields.

With European corporate bond yield spreads widening amid financial
stress, “increases in financing costs can easily be transmitted between
the United States and Europe,” they write.

“During times of financial turmoil, even companies with good
fundamentals and strong growth potential may find it expensive to tap
bond markets,” the economists say. “This is why it is important to
assess the vulnerability of the U.S. corporate bond market to European
shocks.”

To determine the amount of vulnerability, they compare yields for
both financial and nonfinancial corporate bonds in the U.S. and Europe
over the past three years to come up with a “contagion coefficient.” For
the most part, they find that spreads “have moved hand-in-hand,”
although “in 2010 and 2011, fluctuations in euroarea corporate bond
spreads were larger than those in the United States.”

They find that the “coefficient” increases more in “European news
weeks” in which there is bad European news and/or low volatility in
U.S. markets, than it does in “downgrade weeks,” in which a European
nation’s credit rating has been downgraded.

In general, they find that a one percentage point increase in
eura-area corporate bond spread leads to a 0.67 percentage point
increase in U.S. corporate bond spreads during “European news weeks”
compared to a 0.44 percentage increase during “downgrade weeks.”

The economists also distinguish between the behavior of corporate
bond of different grades in financial and nonfinancial markets.

“For the nonfinancial sector, contagion coefficients are higher for
lower-rated bond issuers,” they write. “In particular, bonds of
AAA-rated nonfinancial U.S. issuers are significantly insulated from
bond market funding shocks originating in Europe.”

“The opposite is true for financial borrowers,” they continue. “The
highest rated appear to be more susceptible to contagion from the
European bond market.”

Hale, Marks and Nechio say “this may be because higher-rated
financial institutions tend to be larger and more involved in global
capital markets, which makes them more vulnerable to foreign financial
market shocks.”

“In fact, some of the AAA-rated banks are multinational
institutions that issue bonds in both Europe and the United States, and
are components of U.S. and euro-area AAA bond indexes,” they note.

“By contrast, highly rated nonfinancial companies tend not to rely
much on foreign financing,” they write. “Therefore, they are more likely
to be insulated from financial shocks, especially those originating in
foreign countries.”

As MNI reported last week, “the recent rise in global uncertainties
has also impinged on high-grade corporate bond issuance, which has
fallen in May to slightly more than $88 billion from just over $127
billion in the same year-ago period.”

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]