Investment grade bonds data: Hover over the charts to see the values at a given date. iBoxx EUR Corporates Index data provided by Markit Group Ltd
i) Euro Investment Grade Bond Index: Corporate Spreads
The period from late 2007 through to Q1 2009 coincided with the greatest widening in credit spreads ever seen. The excess systemic leverage/structured product bid leading to very tight spreads markets in the preceding 2003-2007 period was spectacularly undone.
We recovered hard in 2009 once the central bank easing began with money looking for a home in cheap, high yielding corporate bonds. 2009 coincided with the greatest spread tightening era ever seen.
While corporate bond markets sold off in late 2011-2012, we have seen a good recovery since. The compression trade, between high and low beta corporate bonds all the way down to and including the HY market was a key feature in the 2012-2014 years.
We go into 2017 expecting only a modest tightening in spreads and the Markit iBoxx index is unlikely to visit the record lows. Even with the ECB lifting over €1.8bn of IG non-financial debt a week (10% of the eligible market overall) we are failing to see any material tightening.
ii) Investment Grade Bond Index: Corporate Spreads 2015-
Q1 2015 threatened to see spreads tighten further into their all-time lows as the Markit iBoxx investment grade bond index fell through B+100bp. Unfortunately, macro jitters and contagion from the US shale bubble busting impacted corporate bond markets and we have seen some severe retracement in spreads through 2015 and early 2016.
The emissions scandal around VW served as a reminder of the single name event risk that can impact corporate bond markets even for blue chip national champions. It is unlikely that we see a meaningful recovery in spreads unless we see stability in global macro.
There is evidence, through primary bond markets, that corporates still curry much favour, but with volatility as it is in equities and government bonds, secondary valuations will improve only in laboured fashion. And that is what we have observed through the opening quarter of the year with just 6bp of tightening in the cash index. The ECB has been lifting an average of €1.7bn of IG non-financial debt for the best part of 11 months, but we’re not tightening as we might have expected.
iii) Investment Grade Bond Index: Corporate Yields
Yields from investment grade bonds have also backed up but the rally in the underlying has helped keep them at still very low levels. We have been as low as 1.02% on the index and as high as 1.80%, but the we’re lacking a clear trend now. There is a range being established in the 1.20-1.30% area.
We are unlikely going to see the heady heights of Q1 2015 in corporate bond yields, unless, a Goldilocks economy and continued low default rate across Europe is complimented by a less volatile macro outlook and reduced levels of headline risks. That might spur on the compression trade and with underlying yields anchored, credit spreads could resume a ratchet tighter.
The chart shows how the corporate bond market has benefited from QE, the need by investors to buy safe, higher yielding assets while the high levels of demand have promoted the disintermediation in funding for the corporate sector. Now, the best we can hope for is that we stay in the established range for 2017.
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