The Daily Update - Microsoft issue, monetary policy and US employment

Taking advantage of record low borrowing costs, Microsoft launched one of the largest corporate bond deals on record; the seven tranche issue was worth USD19.75bn. Raised to fund its USD26bn acquisition of LinkedIn, the deal was over 2.5 times oversubscribed as investors continue their hunt for yield. The 10-year tranche for example was issued at 90bps above the benchmark UST, at 2.24%.

The AAA rated bonds offered “attractive” yields above USTs, especially at the long-end; so much so that the announcement of the deal actually moved Treasury yields higher on Monday, from the multi-week low levels on Friday. Microsoft is one of only two US non-financial companies which rating agency Standard and Poor’s rates triple A; the other being Johnson and Johnson.

We hold a Microsoft bond on our global bond portfolio; the 4.2% 2035 issue is currently trading over 100bps wider than similar bonds, and offers a yield over 3.4%. With over 5.5 notches of credit cushion for a AAA bond we remain comfortable with this holding which offers an attractive risk-adjusted expected return around 13.5%. Using our proprietary model we equate to a capital gain of ~16.5 points.

As US economic data prints continue to paint a mixed picture, several Fed members this week expressed their views on future rate guidance. Known dove, Chicago Fed President Evans stated “one rate increase could be appropriate this year” despite his concerns that inflation remains below the central bank's target. Atlanta’s Lockhart said he cannot rule out a rate hike at the next meeting in September, while New York Fed President Dudley, most closely aligned with Fed Chair Yellen, appeared very cautious highlighting the greater downside pressures on economic growth both domestically and abroad.

Across the pond, the Bank of England today cut its official rate by 25bps (to 0.25%) and expanded the existing QE programme by GBP60bn to GBP435bn. Following in the footsteps of the ECB the central bank added GBP10bn of corporate bond purchases (to be spread over the next six months), and announced the introduction of the Term Funding Scheme, which will be used to provide banks with funding to encourage them to pass the “close to Bank Rate” on to businesses and consumers. As we mentioned yesterday, policy easing in the UK is a necessary step to prop up growth and avoid a dreaded recession. Governor Carney left the door wide open to take rates lower in the upcoming meetings, especially as he sees inflation rising and growth close to 0% into the end of the year. “Carney Carnage” saw the pound plummet 1.7% against the dollar after the announcement, and 10-year Gilts fell to all-time lows, trading at intra-day lows around 0.646%.

Market focus will tomorrow turn to the all important US non-farm payroll release. The ADP Employment reading for July slightly beat market expectations, predicting an addition of 179k jobs. Standing for “Automated Data Processing”, ADP has more recently become less reliable in predicting non-farm payrolls having missed the very weak May reading (although anomalous) and overestimating the June reading. Market expectations are for an additional 180k jobs created in July, with the unemployment rate falling to 4.8%.

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