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Macroeconomics

09 April 2019

END OF THE ROAD FOR CREDIT 

Equity markets have rebounded resoundingly from the lows seen last December. So have credit markets. Trackers for US high-yield bonds have completely wiped out the loss seen in the fourth quarter of 2018. The outperformance versus government bonds is massive. That is because the spreads have been coming down. From around 540bps at the start of the year, US high-yield spreads have fallen close to 370bps today. In Europe, the iTraxx X-Over 10-year index which follows the CDS for sub-investment grade corporates, has seen its spread fall from 430bps to around 300bps today. By the way, that level is very close once again to the five-year lows seen before.

Low credit spreads for low-quality companies should signal all is hunky-dory in the economy because they signal very low levels of risk for companies with poor quality balance sheets. And yet, the entire world is making a gigantic fuss of the inverted government bond yield curve. The inversion is for most a clear signal we’re likely heading for a recession or a serious growth slowdown. Quod non?

The credit spreads are telling another story. Still, look at some data and it is mixed at best. German factory orders for February fell at their fastest pace since the financial crisis. But, forwardlooking PMI data have improved somewhat globally.

Of course, there is the story of liquidity. Trillions of dollars are sloshing around the globe in search of yield. With yields this low, thanks to central banks, investors seem willing to take a punt at high yield. Yet, in the past, the spreads also tend tob drop to extremely low levels prior to most recessions. They spike again as growth nosedives and the central banks cut rates leading to a steepening of the yield curve.

Whatever you may think of the current credit spreads, they seem to offer very little value to me. Add the fact that in the investment grade arena, the percentage of BBB-rated bonds has largely increased, the odds for a slew of bonds falling into the junk bond category only makes matters worse. Time to hit the exit for risky credits.