The premium between corporate debt and US Treasuries has fallen to its lowest level in more than a decade, a sign that investors are growing confident that recent increases in inflation will not hamper the economic recovery.
The collapse of the difference between investment returns — known as the spread — means buyers are charging a much lower premium than before for owning corporate debt, which is riskier than super-safe US Treasuries.
The spreads between US Treasury and corporate bond yields narrowed significantly this year as investors grew more confident and begged for even marginally higher-yielding assets in a low-yield world.
That compression of the spread, which reflects the risk investors take in lending to companies compared to the US government, came under pressure from the specter of higher inflation from mid-April to May.
However, an increasing number of investors are getting around to the Fed’s mantra that price increases will be transient as the economy reopens after the pandemic, pushing inflation expectations lower.
“The Fed has checked the temporal story that has given confidence to corporate bond investors,” said Adrian Miller, chief market strategist at Concise Capital Management. “Investors in corporate bonds are after all more focused on the expected strong growth path.”
Confidence in the economic recovery was further bolstered on Wednesday as Fed officials signaled a shift toward the eventual withdrawal of crisis policies, and embraced a more optimistic view of America’s recovery. Fed Chair Jay Powell’s more aggressive tone — including comments that “price stability is half our mandate” at the Fed — has helped allay concerns that inflation could spiral out of control, prompting a more abrupt response. from the central bank was enforced.
The spread between US Treasury yields and investment-grade corporate bond yields fell 0.02 percentage points to 0.87 percent on Wednesday, according to ICE BofA Indices, the lowest level since 2007, and remained unchanged on Thursday. For low-yield – and therefore riskier – high-yield bonds, the spread fell by 0.05 percentage point to 3.12 percent, below the post-crisis low in October 2018. The spread widened slightly on Thursday to 3.15 percent.
The decline in spreads has been supported by the central bank’s accommodative policy during the pandemic crisis and by the federal government’s multi-trillion dollar pandemic aid package. According to a popular Goldman Sachs index, which has sparked a wave of corporate lending from riskier, junk-rated companies, financial conditions in the US are nearly the easiest ever.
Some 373 junk-rated companies have borrowed through the nearly $11 trillion US corporate debt market so far this year, including companies hard hit by the pandemic, such as American Airlines and cruise operator Carnival. Collectively, the high-risk cohort has raised $277 billion, a record pace and 60 percent more than a year ago, according to data provider Refinitiv.
However, the decline in spreads and investors’ risk perception were not enough to outweigh a general rise in yields, which were further shocked by the prospect of rising interest rates as investors adjusted to a faster pace of policy tightening. Fed.
Higher-rated debt, which is safer but offers less diversification to protect investors from a jump in government bond yields, tend to suffer more in environments of high growth and rising interest rates. High-yield bonds, on the other hand, tend to benefit, with the booming economy making it less likely that companies will fail.
“For now, people are not at all afraid of the price action of higher interest rates,” said Andrzej Skiba, head of US Credit at BlueBay Asset Management. “Businesses are doing very well and we are seeing a meaningful recovery in earnings.”
Yields on investment-grade bonds are up 0.3 percentage points to 2.08% since the start of the year, compared with a 0.27 percentage point drop to 3.97 percent for high-yield bonds.
Analysts at the Bank of America expect the two markets to converge, predicting that investment-grade spreads will widen to 1.25 percent and that high-yield bond spreads will continue to narrow to 3 in the coming months. 00 percent.
While optimism about the recovery in the US abounds, the continued push for lower-quality corporate debt has caused consternation in some quarters. Investors worry that precarious companies are being offered credit at interest rates that do not take into account the high levels of risk.
“It is very important to us that the return we receive on a high-yield bond provides an appropriate compensation for the credit risks of investing. Of course, when yields are that low, it’s harder to tell,” said Rhys Davies, Invesco’s high-yield portfolio manager. “It’s pretty simple. The lower the returns in the high-yield market, the more carefully investors have to navigate the market.”