The million dollar question in the Asian credit markets have to do with Formosa bonds – for the uneducated here, Formosa was formerly the name of Taiwan, which for the more uneducated is an Island off of China, which for the more uneducated is a country where Mulan took place :)

High-grade index spreads are steadily declining, Bank of America Merrill Lynch’s Hans Mikkelsen notes, as a global correlation divergence is at work. In a report titled “Perfect storm=bump on the road,” Mikkelsen looks at the global supply and demand balance and concludes that recent flow of corporate bond supply from Taiwan is likely to be a temporary market influence.

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Formosa Bonds - Amid "bloated" corporate bond dealer supply, a host of issues leaving investors "underwhelmed"

Calling the declining interest rate market “not helpful” to yield spreads, Mikkelsen pointed to a decline in ten and thirty year US government debt that has been dropping since the middle of July.

The current yield decline, attributed to a dovish Bank of England balking at normalization, a limp read on US ISM Non-manufacturing of 53.9 vs. consensus 56.9 and even extends to US Special Counsel Robert Mueller impaneling a grand jury, is all leaving yield-sensitive investors “underwhelmed” and “defensive.”

The Thursday report, out before strong jobs numbers Friday morning that sent the ten-year note up nearly 1.7% on the day, pointed to smaller idiosyncratic developments that have occurred amid “bloated” bond dealer inventories.

Dealers maintained $125 billion of supply, with a heavy emphasis on long duration corporate bonds in Communications and Healthcare sectors standing out on a net basis. Hurting demand has been tepid weekly buying patterns out of Asia “which always raises our suspicion that Formosa bonds are being issued in Taiwan.”

The Formosa bonds, Taiwanese bonds issued by foreign corporations in a currency not dominated in local terms, came on line thanks to Verizon and Intel. In part, this explains sector weakness, Mikkelsen observes.

Formosa bonds

Drop in near term interest in corporate bonds is due to corporate and sector specific issues

The idiosyncratic issues – including sagging oil prices leading to weakness in related corporate bonds and Teva Pharmaceuticals issuing “horrible guidance” – were cause for sector bond weakness of late.

But don’t fret, bond investors. “All of this will pass,” Mikkelsen observes. The supply imbalance created by the Formosa bonds will change to a more normalized level. “That means Asian buying in the back-end will return."

The supply component of the market will also start to be reduced in the US, which is likely to exhibit seasonal slowness as August comes into focus on bond dealing desks.

When evaluating interest rates, look to performance drivers to understand the potential strength of the trend. Weak US economic data, which is assumed to have enhanced significance, will send a different message than will dovish foreign central banks. Friday's strong US jobs number has answered that question to a degree.