U.S. investment grade (IG) corporate bond year-to-date total returns (-5.3%) are off to one of the worst starts ever, driven almost entirely by the steady climb in rates, as credit spreads are essentially unchanged. The IG corporate option-adjusted spread (OAS) currently sits at 95 basis points (bps), wider than the year-to-date tights of 88 bps, and only about 20 bps back of the tights since 2000.
Meanwhile, with the Federal Reserve’s (Fed) commitment to a zero-interest-rate policy, we witnessed the Bloomberg Barclays U.S. Corporate Bond Index duration steadily march higher to a record of 8.80 years in early January. The rate rise of late has led to a modest decline from these record duration levels.
While corporate credit spreads are not at absolute tights, the incremental spread pickup per year of duration is the slimmest it has been since before the financial crisis. At the end of February, the index provided only 10 bps of spread per year of duration, as seen in today’s chart. For the 15-year period, the average spread per year of duration was 24 bps. Admittedly, in addition to the Fed’s rate policy, the index extension is also a function of the increased long-end issuance. The amount of outstanding long corporate debt is at a high of 36% of the corporate index, having climbed steadily since the 20-year low of 22% in 2005. Issuers have been opportunistic in tendering for short paper and issuing in the long end of the curve to take advantage of the unprecedented low-rate backdrop.
This march to thin spread pickup for the ever-increasing interest rate risk has occurred while the IG corporate index has experienced a steady climb in BBB-rated bonds. The percentage of the IG corporate index in BBBs still sits near the record of over 51%. Since the year 2000, the low for BBBs in the index was 24%.
Although IG corporate spreads are relatively tight in this low-rate, high-duration environment, the global investor base for IG credit has been awash in cash and I suspect to see meaningful allocations to U.S. corporates continue. With the economy poised to exit pandemic lockdowns, and with strong consumer balance sheets ready to spend, the backdrop for further performance is supportive as long as increases in yields are relatively orderly. In addition, the strong equity performance along with the rise in interest rates could see pension rebalancing into corporate credit going forward.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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