The rift between corporate debt and U.S. Treasuries has fallen to its lowest level in more than a decade in a sign that investors are confident growth of recent inflation increases they do not prevent economic recovery.
The widening gap between investment returns – known as spreads – means that buyers require a much lower premium than before to have a corporate debt, which is more risky than super-safe US Treasuries. .
Spreads between the U.S. Treasury and corporate bond yields have narrowed markedly this year, as investors have gained confidence and are demanding to own even marginally higher assets in a low-yield world.
This widespread compression, which indicates the level of risks that investors see in lending to companies compared to the U.S. government, had been under pressure from the spectrum of higher inflation from mid-April to May.
However, a growing number of investors are approaching the Fed’s mantra that price growth will prove transitory when the economy reopens after the pandemic, pushing measures of inflation lower than expected.
“The Fed has controlled the transitional narrative that has provided confidence to corporate bond investors,” said Adrian Miller, market strategist for Concise Capital Management. “After all, investors in corporate bonds are more focused on the expected strong growth path.”
Confidence in the economic recovery has been reinforced by more Wednesday as well Fed officials have reported a shift toward the eventual abrogation of crisis policy measures, embracing a more optimistic outlook for America’s resurgence. The softer tone of Fed chairman Jay Powell – including comments that “price stability is half of our mandate” at the Fed – helped mollify concerns that inflation could spiral out of control, forcing a sharper response from the central bank.
The spread between U.S. Treasury yields and the yields of investment quality companies fell 0.02 percentage points to 0.87 percent Wednesday, according to the ICE BofA Indices, the its lowest level since 2007, and hasn’t changed since Thursday. For lower-yielding – and therefore riskier – bonds, the spread fell from 0.05 percentage points to 3.12 percent, below a post-crisis low last sector in October 2018. It widened modestly to 3.15 percent on Thursday.
The slide in spreads has been stimulated by the central bank’s housing policies through the pandemic crisis and the federal government’s multi-billion dollar pandemic aid package. Financial conditions in the United States are close to their easiest on record, according to a popular index managed by Goldman Sachs, which has spurred a wave of corporate lending by riskier firms.
Some 373 validated companies have borrowed through the $ 11 billion corporate debt market in the United States so far this year, including companies hard hit by the pandemic as well. American Airlines is a cruise operator Carnival. Collectively the risky cohort raised $ 277 billion, a record rate and an increase of 60 percent from last year’s levels, according to data provider Refinitiv.
However, the fall in spreads and the perception of risks by investors have not been enough to overcome a general rise in yields, which have been outpaced higher by the prospect of rising interest rates. investors are adapting to a faster pace of policy tightening by the Fed.
Higher-rated debt, which is safer but offers less spread to hide investors against a jump in Treasury yields, tends to suffer more in high-growth, growing interest rate environments. High-yield bonds on the other hand tend to profit, with the growing economy making it less likely that companies will fail.
“At the moment people are not afraid of the price action of a higher move in yields,” said Andrzej Skiba, U.S. head of credit at BlueBay Asset Management. “Companies are doing really well and we’re seeing a significant recovery in earnings.”
Investment bond yields have moved 0.3 percentage points higher to 2.08 percent since the beginning of the year, compared with a 0.27 percentage point drop to 3.97 percent for high-yield bonds.
Bank of America analysts expect the two markets to continue to converge, predicting that investment quality spreads will widen to 1.25 percent and that high-yield bond spreads will continue to fall to 3.00 percent in the coming months.
However, while optimism about the U.S. recovery abounds continued zeal for lower-quality corporate debt has caused consternation in some quarters. Investors worry that precarious companies are offering credit at interest rates that do not take into account the high levels of risk involved.
“It’s very important to us that the return we receive for a good high return offers an appropriate level of compensation for the credit risks of investing. When returns are low like this, this naturally becomes harder to say.” , said Rhys Davies, high-performing portfolio manager at Invesco. “It’s pretty simple – the lower the yield on the high-yield market, the more investors need to navigate the market.”