Institutional yield buyers in the fixed income credit markets have been waiting a long time for Treasury rates and absolute yields to increase. Since rates hit lows last summer, it appeared that the move higher in yields was finally going to materialize, particularly following the election results in which 10- and 30-year Treasury rates rose almost 80 basis points (bps). However, the very strong tightening in credit spreads has flattened the industrial credit curve quite substantially. As a result, despite the back-up in long Treasury rates, the all-in yield for long industrial credit has been largely offset.
Today’s chart shows the outperformance of long industrial credit spreads relative to intermediate credit spreads along with the move of the 30-year Treasury yield since 2014. Over this period, the relationship of industrial curve flattening and 30-year Treasuries has been highly negatively correlated.
It appears the move has paused for the moment as the pace of rate increases has slowed. New issuance for credit in January was near a record high, with over $170 billion and about 35% ahead of last year’s pace. However, long issuance has not been a meaningful component in the calendar. With foreign demand for credit remaining strong and increasingly concentrated in the long end of the curve, long spreads have been well bid. Long industrial spreads in isolation have compressed to about 25 bps of the tights experienced in 2011 and again in early 2014.Key Takeaway:
The aggressive move tighter in long industrial credit spreads has largely offset the backup in long Treasury rates, providing yield-hungry buyers little satisfaction. This leaves these investors in a challenging position. Long spreads have some room to tighten from a historical perspective, but the risk of buying flatter credit curves adds duration risk at a time when the new administration is trying to reflate the economy.
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