Charts with a left and right Y-axis are often imperfect, but comparing that yield spread to the S&P 500 since the end of 2017 shows a tight fit, especially during bouts of risk-aversion like the final months of 2018 and in August 2019. Corporate bonds retreated from their extremes at a much sharper pace than U.S. equities this time around, which isn’t entirely out of the ordinary but supports the idea that the steep drop in stocks wasn’t just a short-term blip.
Now, as I’ve noted before, some technical factors are at play in corporate-bond indexes. For example, part of the reason the yield spread between double-B and triple-B bonds narrowed so much in 2019 was because triple-B duration rose while double-B duration dropped by the most on record. The duration of the double-B index spiked higher earlier this month, which, all else equal, would tend to widen the spread, though it didn’t appear to do so.
Also of note: Debt from Kraft Heinz Co., EQM Midstream Partners LP and EQT Corp. remains in the triple-B index for now, even though the ratings of all three companies were cut to junk recently. Again, in theory, bonds from “fallen angels” would have higher yields than before the downgrades, which would narrow the spread between double-Bs and triple-Bs. All told, it’s probably safe to conclude that these factors are small enough and slow-moving enough that they don’t alter short-term spread movements very much.
As of Feb. 24, the option-adjusted spread on double-B bonds has jumped to 2.62 percentage points from 1.82 percentage points to start the year, while the spread on triple-Bs is up to 1.35 percentage points from 1.2 percentage points. For some context, those spreads reached 3.65 percentage points and 1.68 percentage points, respectively, during the height of the December 2018 market squeeze. That suggests the high-yield market in particular could be in store for further pain if sentiment doesn’t turn around soon.
As for the U.S. investment-grade market, companies aren’t taking any chances with new deals, even with Treasury yields setting record lows. Bloomberg News’s Michael Gambale reported that at least four issuers stood down on Tuesday, marking the first two-day break to start a week since July 1 and July 2. (He excluded the December holidays and the typical two-week summer hiatus in late August in this analysis.) That’s hardly a vote of confidence from the C-suite on the state of the financial markets.
The follow-through from stocks to credit is worth watching in the coming days and weeks. As much as traders like to quip that the Federal Reserve is most concerned about the S&P 500, or as much as they use Treasury yields to estimate how many interest-rate cuts are “priced in” for the year, ultimately a lack of market access for companies that need it is a truly perilous situation.
Recall that December 2018 marked the first month in 10 years with no speculative-grade bond sales. The Fed quickly pivoted in January 2019 — but what if looser monetary policy isn’t as effective this time around? Lower short-term interest rates mean relatively little in comparison to the Centers for Disease Control and Prevention telling Americans to prepare for significant disruptions of daily life if the coronavirus outbreak begins to spread locally in the U.S., deeming it “not a matter of if, but a question of when, this will exactly happen.”
Without a drastic shift in what’s known about the coronavirus, corporate-bond buyers may need to take a similar approach. It no longer seems a matter of if, but of when, spreads widen further in the riskiest corners of the debt markets.
This article was provided by Bloomberg News.