This week’s global bond market convulsions were dizzying, leaving investors with much to ponder. The Bank of England jolted global markets on Wednesday with its whipsaw policy change from quantitative tightening to quantitative loosening, providing ephemeral relief to bond prices, but ultimately adding to the volatility, sending yields higher to finish out the week. Yields went up so sharply that they even caught the attention of consumers, especially in the US, where the 10 year breached a level not seen in over a decade. Per the Wall Street Journal, “The benchmark 10-year U.S. Treasury yield settled at 3.707%…down from as high as 4.017% in the overnight session and its Tuesday close of 3.963%, marking its largest one-day decline since March 2009.”
For US home buyers, a very unwelcome development.
But even for financial professionals, especially deal advisory and capital markets personnel at the largest investment banks, this week’s most interesting developments in bond markets must have seemed like ‘piling on’. Goldman Sachs led the procession of bad news on Monday with a formal announcement of layoffs, followed by RBC on Friday. For sure, the ‘Go-Go’ 2021 year of bulge-bracket excesses, characterized by surfeit new issues and marquee SPAC deals, is over.
(Not entirely unforeseeably, as I wrote earlier this year)
But, yet, this slowdown in deal making and M&A is a symptom, not a cause. It’s how the bond market is affecting the ability of companies to finance growth that’s really driving the decline. As seen in the chart above, AAA corporate paper is now trading with an effective yield above that not seen in over a decade, at 4.65%, up almost 140% YOY. This is the result of central bank tightening, and how the same is causing the deterioration of corporate creditworthiness as greater borrowing costs and inflation are eating into profitability.
For companies seeking growth, including through acquisition, debt issuance in the public markets is indicating that there’s going to be a continued slowdown in M&A, and a plunge in valuations, as the corporate cost of capital – at least in the next 6-12 months – is skyrocketing. And it won’t be long before the private markets see the same. Though there’s already plenty of evidence that early-stage private equity – Venture Capital – is being battered by these borrowing cost constraints, it’s highly likely that their later-stage, Growth Equity and LBO brethren, will soon experience the same.
Until there’s some normalization in rates, corporate debt financing will remain extremely challenging, and M&A activity and valuations will be negatively impacted. So, continue to watch the yields on short-term corporate paper, because as it goes, so too shall M&A.