It's a Smallish World

It's a Smallish World

With talk of tariffs and guesses about an indefinite future rippling through the headlines, it’s timely to focus on markets instead...

Notably, this past week has seen new economic data about inflation and employment in the U.S., along with smaller developments with larger symbolic importance.

Klaus Regling, managing director of the European Stability Mechanism made a startling comment in a newspaper interview, that the precautionary credit line available to Greece was “probably not needed”. While the phrase was startling, it was also hedged in the same sentence: “…if everything remains quiet, reforms continue, and Greece continues to develop its market access”. But Greece’s troubles are not yet behind it, with approvals for additional forms of debt relief still under review by members of the so-called Troika – the European Commission, the International Monetary Fund and the European Central Bank – each with its own requirements and mission.

On the Rise: Yields, not spreads

The credit spread for US high-yield bonds has come down significantly since February 2016, and has continued its fall since the U.S. election of November 2016. It has ranged between 3.79% and 3.11% over the past 6 months, and is now at about 3.39%.1

Bloomberg Barclays US Aggregate Index

Source: Bloomberg, March 13, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

That relative calm has masked more interesting movements .  The yield of the Bloomberg Barclays US Aggregate Index, with a duration of about 6.75 years, has moved up smartly along with the general interest rate environment, and stands at 3.16% as of March 13, 2018.  But the yield to worst for the High Yield Index has moved up solidly as well, from a recent low of about 5.31% on October 24, 2017, to 6.17% as of March 13, 2018. While that’s a far cry from the 10.1% yield reached on Feb 11, 2016, as tension around the U.S. Federal Reserve’s interest rate policy spiked, it’s still a noticeable move.

Is the HY yield rise a sign of deteriorating credit conditions for that particular part of the market? With economic conditions in the U.S. and elsewhere fairly strong, that seems surprising. Is it due to conditions in the oil and gas business, where high yield debt is often the rule instead of the exception? Also a possibility. Only time will tell for sure.

On the Slide U.S. Yield Curve Flattery

Observers of the US Treasury market had been fretting  until recent weeks about the flattening of the yield curve, worrying about everything from below-target inflation to the  imminence of recession where little other supporting data was in evidence.  But data supporting U.S. growth, especially after passage of the recent tax law and a robust quarterly earnings season for U.S. companies, had pushed the longer end of the curve upward. 

 

Trump Tariffs

Source: Bloomberg, March 13, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

But the recent consumer price index data, combined with a weak report on retail sales, renewed the downward move of the longer end. As of March 13, the 2-year 10-year spread is at about 55.16 basis points, having moved down from the high 60-80 bps range in the end of January – middle of February.  The 10-year-30-year spread reacted less strongly to both the legislation and the equity market scare during that time, only moving up a few bps and was at 24.01 bps as of March 14, 2018.

With the recent discussions about the form and extent of tariffs, concern about the effect on growth may be affecting fixed-income markets at the margin.But it’s more likely that fixed income markets are waiting to read the Federal Open Market Committee’s interest rate forecast – the closely-watched “dot plot” – contained in next week’s Federal Reserve report.

 


1 Source, Bloomberg, March 13 2018. Bloomberg Barclays US HY Index OAS (option-adjusted spread).

 

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