SLC Management and its affiliated investment managers will offer their alternative investment strategies to the U.S. high net worth market.
Helping investors meet their current cash flow and future capital appreciation goals.
Unlimited access to our bond offerings and dedicated, personal support
Customized portfolios selected and managed by professional managers
Partnering with select institutional managers
Expert advice, ongoing trade support, and transparent pricing
An emphasis on solid investment disciplines and specific asset classes
March 04, 2024
January 29, 2024
TOP
Financial Industry Insights from Advisors Asset Management
On November 25, 2013
Viewpoints from AAM - Spreads, Interest Rates & Tapering. What’s a Corporate Fixed Income Investor to Do?
By Mike Lanier
Reviewing the current corporate bond market we find familiar trends: corporate earnings growth continues to fuel a strong stock market; balance sheets are in very good shape with lots of liquidity, and easy access to capital markets has allowed companies to extend maturities at very attractive interest rates. With stocks hitting new highs, credit risk appears to be remarkably low. You would expect to find credit spreads also reaching all-time lows but that is not the case. While spreads have returned to the May lows for the year this week, which is also the lows for the last five years, spreads still remains noticeably higher than where they were before the '08 Great Recession. The same is true for the high yield market. The spread appears "cheap" to underlying default risk, especially when you consider that U.S. Treasury interest rates, the "risk-free" rate built into corporate bond yields (i.e. credit spread = corporate bond yield minus matching-maturity U.S. Treasury yield), are much lower than when credit spreads did hit lows 6-9 years ago, making today's credit spread an even more attractive alternative to buying U.S. Treasuries than the same spread would be in a higher interest rate environment (a.k.a. the credit spread "premium" to U.S. Treasuries).
The explanation of why spreads are so "cheap" can be traced to the same source that is driving so many markets today: The Federal Reserve. The Fed's zero-cash rates are forcing money into markets in the search for yield, adding demand to both stocks & bonds. Their quantitative easing program of buying $85 billion a month (approximately $1 trillion a year) of U.S. Treasuries and mortgages has resulted in very low, longer interest rates, especially since 2011. The fear of where rates will go when the Fed begins to "taper" these monthly purchases has investors reluctant to test new, post-recessions lows in yield and spread. The potential damage was demonstrated last June when the first talk of tapering began and the 10-year Treasury yield jumped from just over 1.6% to 3% by early September. Corporate bonds saw a jump in yield of 100 basis points in the same timeframe. The Fed began back pedaling their rhetoric about tapering right away to stem the damage and remains reluctant to get specific about tapering. Expectations are that the new Fed Chairman-Elect, Janet Yellen, will be even more dovish about rates than departing Bernanke. In theory, current U.S. Treasury rates should reflect the eventuality of the impact of tapering, but as this is new ground for all players, involving unprecedented amounts of Fed intervention, forecasting leaves investors less comfortable than they're used to. Hence the caution to take yields much lower than they have been post-recession, with a wait & see attitude to what tapering will really mean.
Given all that, it seems likely that we will end 2013 in much the same place we find ourselves today, in both yields and spreads. Expect to see most volatility taking place on the longer end of the yield curve (+10 years) as this is where traders spend most of their time, while buy & hold investors usually focus on shorter maturities (seven years and shorter). There should be a flurry of new issuance of corporate bonds in the last few weeks of the year as companies dress their balance sheets and bankers look to post more commission, followed by the traditional slow start of the New Year. More serious talk of tapering will come, and the specter of addressing the debt ceiling and the budget, all of which should make for generally higher volatility in both debt and equity markets. In the meantime, we will continue to enjoy arguably "cheap" credit spreads in the corporate bond market, which are especially attractive in the 5-7 year range where yields are still well over 3% and volatility should remain much more subdued than reaching longer for a modest increase in yield which comes with much more duration risk.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.
topics
Be the first to read our latest posts.