An Anomaly in the U.S. Bond Market

April 1, 2010

Bloomberg News recently reported that bonds from several high-quality corporate issuers have traded at a slightly lower yield-to-maturity than comparable U.S. Treasury securities. These issuers include Berkshire Hathaway, Proctor & Gamble, and Johnson & Johnson. This is a disturbing development because U.S. Treasury bonds are 1) perceived as the safest credit available on the capital markets; and, 2) used as the bellwether for pricing the $88 trillion global debt market. In another cautionary event, credit-rating agency Moody’s has warned that the U.S. government could lose its coveted AAA rating if it does not curtail its deficit. Will the U.S. Treasury lose its status as a setter of standards in the bond market?

First, as depicted below, the yields on corporate bonds continue to be generally higher than those of Treasury bonds, despite the above-mentioned exceptions.

U.S. Bond Yields

Source: bank of America / Merill Lynch

In addition, U.S. Treasury securities have some nearly insurmountable advantages over corporate bonds. Because they are backed by taxpayer money, they are perceived as being safer than corporate bonds. They also enjoy greater liquidity because they are issued in very large amounts and with very uniform features. By comparison, corporate-bond issues are small and vary widely in terms of credit quality, seniority of claim (a corporation can issue bonds with a variety of creditor-protection levels) and other elements such as call features, which allow the issuer to call the bonds at par value on specific dates. In short, corporate bonds are vastly more complex to analyze and to trade than Treasury bonds, and therefore markets require a yield premium for that.

In conclusion, U.S. Treasury bonds are likely to remain the benchmark for global markets, since no competing issuer can rival their liquidity and market depth. Nonetheless, the fact that some corporate bonds recently traded at a lower yield demonstrates that the superior creditworthiness of the U.S. (or any other) government is not cast in stone. In the financial markets, there is no such thing as a “riskless” issuer, and the U.S. Treasury is no exception. That is why I believe that a bond portfolio built with a properly balanced combination of government and corporate securities is probably more robust than a portfolio made up only of government bonds.

Raymond Kerzérho

Chairman of the Investment Committee
and Director of Research
PWL Capital Inc.