Rodney Johnson | Wednesday, December 11, 2013 >>
When someone gives you money, it’s usually a cause for excitement. Who wouldn’t want a few extra bucks in their pocket, particularly right around the holidays?
How grateful would you be for an extra $50 or $100? How about an extra grand?
If someone I didn’t know walked up and gave me a thousand dollars, sure I’d be suspicious at first, but then I’d be pretty darn happy.
Based on that logic, companies should be delirious with joy… all thanks to the Fed.
Recently both Microsoft (MSFT) and Johnson & Johnson (J&J) issued corporate bonds. The two companies don’t have a great need of cash – they generate plenty on their own – but the environment is ripe for selling bonds.
Right now interest rates are at ridiculous lows as investors clamor for any yield they can get. This means that strong companies like Microsoft and Johnson & Johnson can place debt for a song.
The low interest-rate environment is of course part of the Fed’s strategy for rebooting the economy, no matter how ineffective it has proven to be. To this end the Fed has held short-term rates to the 0% to 0.25% range, and has used trillions of dollars to buy mortgage-backed securities and U.S. Treasury bonds to force interest rates lower.
As the Fed swipes these bonds off the markets, it not only drives down interest rates but also takes fixed-income inventory off the shelves. This is where Microsoft, Johnson & Johnson, and other high-quality issuers come into the picture.
While U.S. Treasury 10-year bonds yield a scant 2.78%, Microsoft was able to sell 10-year bonds at 3.625%, or a modest 85 basis points more in yield.
Imagine that! Being able not only to sell 10-year corporate debt at such a low rate, but also to sell the debt at such a tight spread to U.S. Treasuries.
For Johnson & Johnson the deal was even better. The century-old company was able to sell 10-year bonds at 2.95%, or a mere 17 basis points above the comparable yield for U.S. Treasuries. Talk about a free money!
There is no way to know exactly what interest rates would be without Fed intervention, but we can safely assume they would be higher. And of course higher interest rates would make debt more expensive.
Just a single percentage point of interest could make a big difference. Considering that Johnson & Johnson sold $3.5 billion worth of debt and Microsoft sold $8 billion of debt, a 1% increase in interest would have meant a $35 million increase and $80 million jump in interest costs per year respectively. And to think that I would have been excited by a mere $1,000.
Of course, the savings don’t come from a magic pot at the end of a rainbow. Instead, the money comes from savers.
While the Fed is busy bundling corporate gifts for borrowers, it’s acting as the miserly Grinch when it comes to savers. Those of us stuck in Whoville can only shake our heads as Ben Bernanke & Co. come down the mountain from the Eccles Building and make off with our hard earned dollars.
The world of investing for income is definitely much harder today than it has been for years. However, there is opportunity, you just have to know where to look. We are fortunate to have editors like Eddie Speed joining our ranks to bring you great alternatives to the typical “buy a bond and be grateful” fixed income way of thinking.
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Ahead of the Curve
For all of time, philosophers have worked to expunge all that is fleeting and artificial in the world, aiming to unveil fundamental truths.