Global Credit: Focusing on Fundamentals

Mid Week Bond Update

Global Credit: Focusing on Fundamentals

While markets respond to headlines, it can be useful to keep an eye on fundamentals.

With global macro factors dominating financial markets in recent weeks, it’s been easy to focus on policy imponderables and be driven to fear or inaction by the constant barrage of headlines.

But behind the backdrop of uncertainty and discomfort lies the opportunity to focus on the aspects of asset pricing that are driven by fundamental factors instead of emotion.  It’s clearly the case that fundamental factors such as the volume and composition of global trade can have an impact on valuation, and therefore asset prices, but even in that case careful analysis can help overcome fear.

The high yield (HY) bond market is a timely example. The rule of thumb over the years has been that the spread of the high-yield sector offers insight about investor optimism – or pessimism – about the market’s outlook for credit quality.

But when disaggregated by sector, it’s clear that generalizations are less useful than analysis of the forces driving profitability in each of them.

High Yield Spreads Differ By Sector

Chart courtesy of Western Asset. Source: Bloomberg, as of 7/25/2019. Spreads shown are for the Bloomberg Barclays High Yield Energy and High Yield Retailers Total Return Indexes, respectively. 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.


The retail and energy sectors offer a case in point. After spiking during the peak of the 2008-9 global financial crisis, sector spreads traded more or less in tandem until the end of 2013, when volatility in crude-oil prices wreaked havoc with the profitability of price-dependent and heavily-leveraged companies in the industry. At the same time, spreads in the HY retail sector remained relatively stable, reflecting the longer-term issues in the sector which continue to this day.

One possible lesson: While risk aversion appears to be a theme recently in credit markets, it’s unlikely that fundamentals will be forgotten in the longer term.

On the rise: The Amount of Negative-yielding Debt

As of August 12, 2019, the market value of the world’s inventory of bonds yielding less than zero percent reached $15.6 Trillion, a near record high. With the rapid decline in yields of U.S. Treasuries in recent weeks, some market participants have been stretching their imaginations to include the possibility of Europe’s negative sovereign bond yields extending to the U.S.  Even former Fed Chair Alan Greenspan said in a recent interview, “There is no barrier for U.S. Treasury yields going below zero.”

The concerns about negative yields in the market for U.S. Treasuries appears to be less a matter of forecasting than a matter of fear that the U.S. economy could potentially slip into a multi-year stagnation reminiscent of Japan’s “Lost Decade” during which economic growth was difficult to find.

But one thing is clear: current market conditions are driving some observers to imagine the heretofore unimaginable.

On the slide: U.S. Break-even Inflation

Despite U.S. core consumer inflation reaching a 2.2% annual rate in July, fixed-income markets are less than optimistic about the prospect of the Fed succeeding in reigniting overall inflation – at least according to breakeven inflation rates.

The 5-year / 5-year breakeven rate reached as low as 1.44% as of August 13, well below the Fed’s 2% stated target rate. It should be noted that this level was reached some two weeks after the Fed lowered its target rate, a move believed by some to help encourage growth-supported inflation.

While it’s possible that these famously fickle figures are currently caught in the backwash of larger forces within the bond market, the fact that the levels have moved in the opposite direction of stated Fed policy is worthy of note.


All data Source: Bloomberg as of August 13,2019, unless otherwise specified.


A sector spread is the difference in yield between fixed income securities in different sectors but with similar maturities.

The Core Consumer Price Index (Core CPI) excludes the prices of food and energy, which are volatile on a monthly basis, from the basket of goods used to determine the CPI.

Consumer Price Indexes (CPI) measure the average change in consumer prices over time in a fixed market basket of goods and services.

The 5-year, 5-year forward breakeven inflation rate is a measure of expected inflation derived from "nominal" Treasury securities and their "real" counterparts—inflation-protected TIPS securities.

An implied breakeven rate is a measure derived from comparing returns of two classes of securities whose value depends on the same factor, such as inflation or default rates.

Break-even inflation is the difference between the nominal yield on a fixed-rate investment and the real yield (fixed spread) on an inflation-linked investment of similar maturity and credit quality.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.



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High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.