March 4, 2014 7:01 pm

US corporate bonds: moving parts

Spreads are grinding lower for both investment grade and junk bonds

A vexing part of investing in corporate bonds is all the moving parts. When yields on US junk bonds, for example, fell to historic lows below 5 per cent last May, bulls happily pointed to spreads. At roughly 400 basis points over Treasuries, they were still well above the all-time tight levels of 233bp back in 2007, according to a Barclays index. Absolute yields on both investment grade and junk bonds have risen off their lows with the climb in benchmark US Treasury rates that has come as the Federal Reserve laid the groundwork to slow its bond purchases and eventually began tapering. But spreads on corporate debt are grinding lower. For both investment grade and junk bonds, they recently reached the tightest levels since the crisis.

Take junk bonds. Average spreads hit 363bp on Friday – the narrowest since July of 2007. Investment grade spreads hit 109bp on the same day. Big issues such as the 10-year bonds of Verizon and Sprint are up 4 and 3 per cent respectively so far this year. Corporates may be benefiting from money coming out of emerging markets. Yields are still low; it has to go somewhere. And after the rallies of the past few years, the upside to corporate and junk debt is limited, although, for now, investors see the downside as relatively low too.

Economic growth in the US may not be as strong as had been hoped. Still, an environment of subdued growth is not terrible for credit. A sharp run-up in rates would not be great but, if it happens because the economy is accelerating, that bodes well for companies, especially the low-rated ones. Treasury bond yields have fallen this year. The larger risk comes if economic growth falters in spite of all the monetary policy used to spur it. Corporate spreads are not back to the all-time lows, but thinner risk premiums still mean less margin for error.

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