Pick The Odd One Out In The Duration Increase Race
In the great pursuit of yield one of the key observations in fixed income land has been the ever increasing duration of bonds, as more and more companies are able to offload debt with ever longer maturities, the recent reissuance of 100 year bonds by Norfolk Southern being just one example of why many are expecting (jokingly, for now) the return of perpetual bonds to be issued by the US government, i.e., never to be repaid. Yet the full picture is not so simple.
As Credit Trader points out, there has been a notable divergence between the duration of Investment Grade credit and High Yield. While the former has seen an increase in average duration by almost over year from the mid-3 range in late 2008, to the current level of just under 4.7, High Yield has continued to not only stay flat, but in fact has declined to an almost all time low of 3.17. In other words, as most companies have been refinancing IG into longer dated position to buy themselves some breathing room for when the next downcycle peaks some time in the next 2-3 years, overleveraged companies in the B2/B space and lower have had no such luck. In fact, as Michael Tennenbaum stated yesterday, the huge problem of the maturity cliff of $200 billion in HY notes over the next 2 years has not been resolved at all, as even irrationally exuberant investors have been burned one to many times, and refuse to be locked into a capital structure they know will collapse at the first indication of increasing rates.
The implication of all this, is that the weakest link in the great refi game has been isolated, and once again, just like before, it is that great Michael Milken invention: high yield. Because even if IG credit avoids the next crash, HY will not be so lucky, and when tens of billions of bonds are unable to be refinanced at maturity, the next major credit domino will topple taking out with it hundreds of billions in cross-colateralized assets, and set off the next liquidity crunch in the US economy.
Chart of average IG duration
Chart of average HY duration