Buyers Tackle a Fear of Debt

Investors, in general, aren't afraid of the bond market anymore.

After a broad selloff in May and June, investors are pouring money back into corporate bonds and riskier types of debt, some with complex structures and favorable terms for issuers. Pension funds, insurance companies, mutual funds and hedge funds are resuming a hunt for higher yields that petered out earlier this spring when the Federal Reserve said it may begin to wind down its $85 billion-a-month bond-buying program, known as quantitative easing.

While bond prices slipped slightly Tuesday, investment bankers from Goldman Sachs Group Inc., Citigroup Inc. and Jefferies Group LLC are plowing ahead with a $1.2 billion commercial mortgage-backed security at some of the lowest yields relative to their benchmarks in two months, investors said. Higher yields threatened to curb commercial-mortgage lending in June as issuers worried that higher interest rates would make their deals too expensive.

In the corporate-bond markets, media company Viacom Inc., whose credit rating was cut earlier this month, sold $3 billion of new bonds Monday with more orders for the debt than it was able to fill. In late July, Kodiak Oil & Gas Corp., rated below investment-grade, sold $400 million of new debt, up from a planned $300 million, with interest of 5.5% annually—the same rate it paid on a $350 million offering in mid-January.

After the spring rout, parts of the bond market went to levels that were "old-school attractive," said Jeffrey Gundlach, chief executive officer of DoubleLine Capital. Mr. Gundlach bought "junk" bonds at the end of June when some yields reached 8% even though corporate defaults remain low. DoubleLine has $57 billion in assets under management.

Paramount Pictures/Everett Collection Viacom Inc. sold $3 billion of new bonds Monday. "SpongeBob SquarePants" airs on Viacom's Nickelodeon.

Investors' return to bonds shows they have begun to buy into the Fed's statements that the financial health of the U.S. is improving, and into its assurances it would pull back only if the economy showed it could withstand less help. As the summer wore on, employment growth was moderate and inflation remained low, which helped ease concerns that the central bank may act quickly. Fed officials also said the central bank has no plans to raise benchmark interest rates before next year.

Money has flowed into investment-grade bond funds since the end of June, including $1.4 billion in the week ended August 7, according to Lipper. After losing $1 billion in May and $15.6 billion in June, high-yield bond funds have seen investors put money back into the market. The funds took in $5 billion in July and $490 million so far in August, according to Lipper.

The selloff "doesn't seem to have had as big an impact as you'd think," said Lynn Peterson, chief executive officer of Kodiak, the Denver-based energy company. He said Kodiak's deal priced much lower than the 6% rate bankers and investors initially had discussed as about $2 billion worth of orders came in.

"As people settled down and thought about it a little bit, the catalyst for the end of quantitative easing is going to be an improving economy," said Joe Mayo, managing director and head of credit research at Conning & Co., which manages $82 billion in assets largely for insurance companies. "An improving economy is positive for risk assets."

Mr. Mayo's firm bought Viacom's bonds and he said banks' bonds are attractive.

Since mid-July, some companies sponsored by private-equity firms also have been able to sell bonds investors deemed too risky in June. The four-week period starting July 18 has been the busiest ever for the sale of payment-in-kind toggle bonds, which allow companies to repay their debt with more bonds if they cannot find the cash, according to S&P Capital IQ Leveraged Commentary & Data.

Companies including Party City Holdings Inc., owned partly by Thomas H. Lee Partners and arts-and-crafts retailer Michaels Stores Inc., partly owned by Bain Capital, recently sold such bonds. Representatives from Party City and Michaels didn't immediately return calls for comment.

The bleeding in the fixed-income markets stopped in recent weeks even as U.S. Treasury rates remain at elevated levels compared with their record low in early May of 1.62%. The 10-year Treasury yield is hovering around 2.7%, while yields on other types of debt have moved lower relative to Treasurys since the height of the selloff. When bond prices fall, yields rise.

"During a panic like we had in May and June, institutional credit buyers take their foot off the gas," said Brian Reynolds, chief market strategist at Rosenblatt Securities Inc. "But once the panic has run its course, they have to buy even more aggressively to make up for lost time."

A rush of new money helped push the average junk-bond yield lower to 6.18% as of Monday, below the 7% levels reached in late June, according to Barclays.

GDP Reading Boosts
European Stocks

European stock markets moved higher on Wednesday, as investors welcomed second-quarter GDP data from the euro zone that showed the region has emerged from a six-quarter-long recession.

Victoria Clarke, economist at Investec Securities, said the upbeat euro-zone data had already largely been priced in, explaining why the index failed to post a stronger gain.

“We’ve seen a wave of survey data coming through a bit more positive lately, and yes the GDP was a bit better than expected, but still in the range of what people had been looking at. So that’s why we’re not seeing a big rally today,” she said.

“It was a good headline for the press, but for the markets there wasn’t a whole lot of new news,” she added.

European markets started to move higher after data showed the euro zone has emerged from an 18-month recession. The region’s gross domestic product rose 0.3% in the second quarter, ahead of market expectations of a 0.1% to 0.2% expansion. The currency bloc’s GDP contracted by 0.3% in the first three months of the year.

But even if the data paint a rosier picture of the area, it is too early to talk of a sustainable recovery, analysts said.

Tom Rogers, senior economic adviser to the Ernst & Young Eurozone Forecast, said “that even in those countries with the sharpest rebounds the pace of recovery is unlikely to be sustained in the second half of the year.” “

Last weeks’ retail sales data underlined the weakness of household spending power even in the north; credit is still only flowing to firms in certain countries, and demand from emerging markets is slowing down,” he said. “More needs to be done if the apparent recovery of the past few months is to be more than simply a bright spot in an otherwise difficult few years,” he added.

The Housing Recovery Begins to Raise Concerns

The real estate market is starting to heat up-so much so in some areas, the "b" word-bubble-is starting to pop up.

"Nationwide, the housing market is not in a bubble. But there are probably some markets that are at risk for getting into bubble territory if they continue at the pace that they're going," said Daren Blomquist, vice president at RealtyTrac.

In a recent report from Realtor.com, the towns seeing the hottest recoveries, based on factors such as inventory, median list price, days on the market and search activity, were primarily on the West Coast, with six of the top 10 in California. Six months ago, eight of the top 10 were in Florida. So, is the recovery, like the settlement of the U.S., moving east to west?

Actually, there are some methods to the recovery madness-but geography isn't one of them.

The pros estimate the housing recovery started just over a year ago. Those early buyers? It was a lot of foreign investors buying up real estate in Sun Belt areas like Miami and Phoenix.

"There were stories in 2012 of people being outbid for homes-individual homeowners getting outbid by all-cash buyers," said Steve Berkowitz, CEO of Move Inc., the parent of Realtor.com.

Blomquist said buying activity really started to pick up in mid-2012 after Warren Buffett said on CNBC that he would buy up "a couple hundred thousand" single-family homes and rent them out if he had the logistical ability to manage the properties.

"That was really when there was a paradigm shift in the market," Blomquist said. "We started to see these institutional investors jump in and buy single family homes."

"Investors really were the leading edge, the front line of this real-estate recovery," Blomquist said. "They're willing to stomach more risk." And that, in turn, helped trickle down to the average homeowner as it helped boost prices and get a lot of homes back above water.

He estimates that roughly 10 to 20 percent of investors buying real estate today are foreign investors-mostly from Canada, Mexico, China and, in places like Miami-South America. He's also heard of a lot of investors from Russia and other eastern European countries in the New York market.

One common denominator is that many of the markets with big price increases had been among the hardest hit when the housing bubble burst.

According to the latest data from RealyTrac, the markets with the biggest recent pickups are Honolulu; Flint, Mich.; and Albany, N.Y.

Another factor has helped speed the recovery in some markets more than others: how the foreclosure process is handled. Markets like California, Nevada, Arizona and Georgia have seen their recoveries take off because they allow what's called a nonjudicial foreclosure process, which tends to be quicker than the courts.

"Those markets have worked through the foreclosure problem more quickly than other markets," Blomquist said. "What that means is that they don't have that lingering distress ... that drags on home prices."

The recovery in California and other parts of the West Coast has largely been driven by the tech economy, Berkowitz said.

So much so, that the recovery in some markets may be getting close to its peak.

In San Jose, for example, prices are 70 percent off their bottom already, Blomquist said. San Francisco is 96 percent off its bottom. "I think many of the California markets, especially San Jose and San Francisco, are getting back to that bubble level," Blomquist said. "Some markets are close to plateauing in terms of home prices but scaling back the pace of recovery to single-digit growth, which going forward is much more healthy."

And, if you're wondering why some big Northeastern states like New York, New Jersey and Pennsylvania aren't on the hot list, you can sum it up in one word: courts. All of those states have a judicial foreclosure process. As a result, the pros are keeping their eyes on these markets.

You may not be able to find a geographic pattern in where the recovery will heat up next, but what the pros are seeing now is a lot of West Coast markets getting close to peak and a lot of East Coast markets, from New York to Florida, with more room to run.

Wholesale Prices Unchanged in July

Falling energy prices kept a lid on U.S. wholesale inflation in July after a jump in gasoline boosted prices in June.

The Labor Department reported Wednesday that wholesale prices showed no change last month compared with June, when they rose 0.8 percent. That was the most in nine months.

Energy costs fell 0.2 percent, after June's 2.9 percent surge. Gasoline prices dropped 0.8 percent, and natural gas costs slid 3.9 percent.

Excluding volatile food and energy costs, so-called core prices rose just 0.2 percent. Core wholesale prices are up 1.2 percent over the past 12 months, the smallest one-year increase since November 2010.

Tame inflation has helped consumers increase spending this year despite slow income growth and higher taxes.

Aside from sharp swings in gas prices, consumer and wholesale inflation has barely increased in the past year. Overall wholesale prices rose 2.1 percent in July compared with the previous July.

For July, drug prices rose 1 percent, the largest gain since a 2.5 percent rise in January. Drug companies have been introducing price increases in January and July of each year. Food costs were flat in July as a jump in pork prices was offset by a decline in the cost of fresh vegetables.

On Thursday, the government will report on consumer prices for July, and economists estimate that overall and core prices rose just 0.2 percent.

For the 12 months ending in June, overall consumer prices rose 1.8 percent and core prices 1.6 percent.

Those levels are below the Federal Reserve's 2 percent target for inflation. At its last meeting in July, the central bank added language to its policy statement to express concern that inflation persistently below 2 percent could pose risks to the economy.

The Fed announced after the meeting that it planned to keep buying $85 billion a month in bonds to keep downward pressure on long-term interest rates. It also said it planned to keep its key short-term rate near zero, where it's remained since December 2008 — at least as long as unemployment is above 6.5 percent.

Chairman Ben Bernanke and other Fed officials have said the central bank could start slowing its bond purchases later this year. Some economists think that could begin after the Fed's next meeting in September. Most expect the slowdown to be gradual. New bond purchases might not end until mid-2014 — and only then if the unemployment rate has dropped to around 7 percent.

Unemployment fell in July to 7.4 percent from 7.6 percent in June. The July figure was a 4½-year low, but it was still well above the 5 percent to 6 percent range that economists associate with a healthy economy.

The combination of modest economic growth and still-high unemployment has kept wages from rising quickly. That's made it harder for businesses to raise prices.

U.S. Household Debt Levels Plummet from Peak

U.S. households are holding less debt and are behind on fewer bills than at any time since before the recession began, putting consumers on a sounder footing to support a stronger economic recovery.

Total household debt, including mortgages, credit cards and auto loans, fell by $78 billion in the second quarter to $11.15 trillion, the lowest level since 2006, according to a report released Wednesday by the Federal Reserve Bank of New York.

The amount of bills 30 or more days late fell by $3.3 billion during the quarter, also reaching the lowest level in seven years.

"Households improved their overall delinquency rates for the seventh straight quarter, an encouraging sign going forward," said New York Fed economist Andrew Haughwout.

The declining debt burden largely reflects changes in the housing market. Mortgage balances fell by $91 billion during the second quarter. Some Americans are in a better position to pay down mortgage principal. Increasing housing values also are allowing sales of homes that previously were worth less than the amount owed.

While total debt is declining, the report offered signs that U.S. consumers are boosting their spending.

Mortgage originations rose to $589 billion, the seventh consecutive quarterly increase. Auto-loan balances increased $20 billion from March to June, the largest quarterly gain since 2006.

Credit-card balances increased by $8 billion during the quarter after falling to the lowest level in more than a decade earlier this year. That suggests Americans are growing confident enough in the economic recovery to finance more of their purchases with plastic.

The fraction of consumer bills that are seriously overdue also declined during the quarter. Only 5.7% of all consumer debt is 90 or more days late, the lowest rate almost five years. The delinquency rate fell in every category measured, including mortgages and credit cards.