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Market Risk - US Bond Issuance Remains Stable in Second Quarter Despite Rising Interest Rates (August 12, 2004)

Location: New York
Author: Emily Brunner
Date: Thursday, August 12, 2004

Compared to the first quarter, US bond issuance kept pace in the second quarter as a strengthening economy helped offset a dampening effect from rising interest rates. Mortgage-related securities made the biggest jump from the first quarter climbing 33 percent in the second quarter to $536 billion. The asset-backed sector also showed continued strong growth, while issuance in the government and municipal arenas remained stable, bringing overall activity for the second quarter to $1.45 trillion, down marginally from the $1.46 trillion issued during the first quarter. For the first six months of 2004, issuance totaled $2.91 trillion, a 19 percent decline from the first half of last year.

"Considering the interest rate volatility this year, the bond markets have responded well to sustained economic growth and should continue to make the transition to the emerging interest rate environment, whether rates continue higher on the path of a stronger economy or stabilize or even ease as a result of more modest growth due to higher oil prices," said Micah S. Green, president of The Bond Market Association.

Second quarter mortgage market volume probably benefited from lower interest rates through March which led to another round of home purchases and refinancing transactions which actually closed during the second quarter. Borrower psychology may have played a role, as consumers may have tried to "lock in" lower rates rather than risk facing higher rates later in the year. According to the Mortgage Bankers Association, mortgage originations increased to $848 billion in the second quarter, up from $601 billion in the first quarter. Going forward, however, should widely anticipated higher rates materialize, there will undoubtedly be an effect on mortgage-related securities issuance. But at the same time it should be noted, the mortgage markets have defied repeated expectations and have remained surprisingly robust.

The asset-backed securities market continued its remarkable growth through the second quarter of 2004, with issuance totaling $201.1 billion, a seven percent increase over the first quarter. With a total of $389.1 billion to date, the sector is on pace to set a new annual issuance record. The current record, set in 2003, is $585 billion. Home equity loans again lead the asset-backed sector, accounting for about half of second quarter issuance. Recent interest rate increases are expected to slow the origination of home equity loans in coming quarters, though this market has developed a track record of resiliency in the past several years.

Treasury bond issuance continued to grow compared to last year shooting to $427 billion during the second quarter of 2004, a 30 percent increase over the same period in 2003. However, issuance actually fell 2.2% compared to the first quarter, a common trend as Treasury receipts tend to rise during the April tax season. Additionally, the mid-year Office of Management and Budget projection of a $445 billion deficit for Fiscal Year 2004 is lower than expected at the start of the year consistent with the expectation the deficit-along with Treasury issuance-will begin to recede after this year.

The supply of new corporate bonds decreased during the second quarter of 2004, dropping 42 percent from the first quarter to $135.4 billion. The drop off in issuance was not unexpected as issuers had rushed to market in the first quarter to seize an opportunity to realize financing at historically low rates. At the same time, credit quality continues to improve in the corporate sector, a function of strong gains in corporate profits, controlled inflation and an overall strengthening economy.

The number of "rising stars," or bonds whose ratings jump from below investment grade status to investment grade has outpaced the number of investment grade bonds that have fallen below investment grade, according to a recent Standard & Poors study. Corporate default rates are also on the decline.

Other survey highlights include:

  • In a special section of this Research Quarterly, strong demand forU.S. fixed-income securities among foreign investors is highlighted. Net foreign purchases totaled $411.6 billion through May 31, 2004, a 40 percent increase over the same period of 2003. Japan is the leading foreign investor in both public and private U.S. fixed-income securities followed by the United Kingdom.
  • Federal agencies' long-term debt decreased 13.7 percent to $589.9 billion in the first two quarters of 2004 compared to the first half of 2003.
  • Total municipal issuance, $212 billion in the first half of 2004, decreased from the same period last year. $243 billion in municipal bonds were issued in the first half of 2003.
  • Continued economic growth led to a net outflow of $22.6 billion from bond mutual funds in the first half of 2004. Over the same period a year ago, $67.6 billion in new money flowed into bond mutual funds.

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