What do bond issuances by financial institutions signal?

13 JANUARY 2024
By Tatyana Marchuk

Credit, business, and financial market cycles are intricately connected. A recurring pattern observed in data reveals that credit booms often trail economic expansions but serve as early indicators of future economic downturns and declines in asset market values. Previous research has explored various channels contributing to these credit-driven fluctuations, such as investor overoptimism, financial deregulation, and time-varying perceptions of risk.

In our paper “Corporate Bond Issuance by Financial Institutions and Economic Cycle,” co-authored with Tetiana Davydiuk and Ivan Shaliastovich, we present novel evidence on the cyclicality of capital flows within the corporate sector. Specifically, our findings indicate that an increase in public debt borrowing by the financial sector acts as a predictor of an impending credit cycle upturn and heightened commercial lending.

Utilizing data on net issuances of equity and bonds by U.S. corporations, we document the distinctive relationship between economic fundamentals and corporate bond net issuances by financial institutions (BNIF) compared to non-financial entities. An increase in public debt net issuances by financials anticipates subsequent growth in bank credit, particularly in commercial and industrial lending.

In contrast, equity net issuances by financial institutions, as well as equity and bond net issuances by non-financial entities, do not exhibit a similar relationship with the credit cycle. Consequently, financial institutions appear to time their corporate bond borrowing in anticipation of forthcoming expansions in commercial credit.

Our study shows that bond issuances by financial institutions align with inflection points in business, market, and monetary policy cycles, offering valuable insights for predicting economic and market conditions one to two years ahead. Specifically, BNIF tends to increase approximately one or two years following periods of high GDP, investment, or earnings growth (business cycle); high equity returns, or low credit spreads and financial volatility (market cycle); or monetary policy tightening (see Figure 1). The economic and statistical magnitudes of the predictability are quite remarkable, with BNIF often standing out among other common predictors of economic and market fundamentals.

Figure 1

Additionally, we establish that our main results are predominantly influenced by net issuances of corporate bonds by banks, brokers, asset managers, and exchanges, as opposed to other financial firms. Examining the time variation in predictability, the predictive versus realized plots suggest that the forecasting ability of bond net issuances by financial institutions is stronger around and after the Financial Crisis, rather than in the beginning of the 1990s (see Figure 2). We repeat the exercise in rolling 10-window regressions and confirm that it is indeed the case for majority of the economic and financial market variables. This timing suggests that post-Crisis regulations in the financial sector may contribute to explaining our findings. 

Figure 2

Overall, our findings not only underscore the cyclical nature of financial activities but also emphasize the importance of monitoring bond net issuances by financial institutions as a potent leading indicator for understanding broader economic trends. The study contributes to our understanding of the intricate dynamics shaping financial markets and the role of financial institutions in anticipating economic shifts.