Foreign Demand Driving Credit Spreads Tighter

March 23, 2017

Foreign Demand Driving Credit Spreads Tighter Photo

Despite recent signs of accelerating growth and inflation in the global economy, central bank monetary policy remains very accommodative. Short-term rates are stuck near or below the zero-level across most of the developed world, and more than $8 trillion in sovereign debt still trades with negative yields. Even BB-rated Portugal can issue 2-year bonds at just over 50 basis points (bps) today, less than half the rate paid by 2-year on U.S. Treasury notes.

Not surprisingly, the proliferation of negative interest rate policies and central bank quantitative easing programs is bringing foreign investors onto U.S. shores. This week’s chart highlights the changing composition of foreign purchase activity in the domestic fixed income markets and its impact on credit spreads. Most notably, China has been selling U.S. Treasuries to help defend the value of its currency. On the other hand, foreign buying of U.S. spread sectors has gathered steam as the Bank of Japan (BOJ), European Central Bank (ECB) and Bank of England (BOE) purchase activity is crowding out investors from their domestic markets. Yields available for corporate and structured securities in the U.S. are attractive given the lack of investable alternatives elsewhere in the world.

Key Takeaway:

Global central banks have succeeded in their attempts to push investors out the risk curve. However, withdrawing excess liquidity from the markets in an orderly fashion is likely to prove more challenging. The Federal Reserve was the first to move beyond ordinary forms of policy accommodation following the credit crisis and now is on the verge of being the first central bank to reduce the size of its balance sheet. The fundamental picture remains constructive for the U.S. economy in particular, but credit spreads have moved to a point which argues for caution during the remainder of 2017.

Tags: Chart of the Week | European Central Bank | Monetary policy | Credit spreads | Bank of Japan | Bank of England | Central banks | Risk curve

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