- After last week’s selloff in US treasuries, the yield spread between government bonds and corporate debt is at its lowest level since January.
- Capital Economics says the narrow yield spread bodes well for the near-term fortunes of the US economy.
- But ANZ rates strategist Martin Whetton said the move has little connection to the outlook for economic growth .
Bond markets are back in focus after the yield on US treasuries rose sharply last week.
More selling on Friday night saw US 10-year bond yields close at 2.96% — the highest level since January 2014.
In the wake of the latest selloff, research by Finn McLaughlin at Capital Economics highlights that rising yields have so far been confined to government bonds, not corporate debt.
He said it makes the latest bond selloff different to the one in early February, which gave rise to a brief stock market rout as the S&P500 had its biggest one-day drop in six years.
In that case, the yield spread between US corporate bonds and treasuries rose sharply as the selling extended across debt markets.
But since then the move has reversed — with government bond yields rising faster then corporate debt.
And the move has been even more pronounced for riskier, speculative-grade corporate bonds. McLaughlin said the spread between high-yield bonds and US treasuries has narrowed by 40 basis points (0.4%) since February.
It’s now returned to the same level it was in January, when US stocks peaked at an all-time high.
According to McLaughlin, such a scenario “provides some reassurance that the wheels are not about to come off the US economy”.
However, ANZ senior rates strategist Martin Whetton said there’s little connection between rate spreads and the outlook for the economic growth.
“It means nothing. Corporate spreads have come in because issuance volumes have slowed and there are still buyers of credit,” Whetton told Business Insider.
“It has no meaningful indications for the economy at all, and for the debt markets is simply a function of supply and demand.”
According to McLaughlin, the yield spread between corporate bonds and government bonds are likely to remain relatively low in 2018. Which means the US economy is likely to stay on track — at least for this year.
“Credit spreads tend to ebb and flow with the business cycle,” McLaughlin said.
“We do not expect the economy to slow materially until next year, once fiscal stimulus has largely worn off and monetary tightening has started to bite. So we doubt that spreads will rise sharply before then.”
Looking at the market more broadly, Whetton said the opportunities for companies to raise debt at historically cheap rates is growing increasingly limited.
“For context, credit spreads have seen the lows that they will trade at in this cycle and for issuers/borrowers of corporate debt, the best days are behind them,” Whetton said.
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