So yeah, the relentless hunt for yield catalyzed and perpetuated by central bank largesse has helped drive equally relentless spread compression up and down (or “down and up”?) the quality ladder.
Can’t getting any yield in govies? Well then I guess we’re going corporate now.
Can’t get anything from IG? Well I guess we’re going HY.
Can’t get anything from HY? Well maybe there’s a struggling US energy producer ready to do a follow-on.
Sh*t, we started in risk-free government bonds and before you knew it, we were the proud owners of diluted shares in a cash flow negative shale producer.
So eventually this has to reverse. Here with some good commentary that speaks to such a reversal is SocGen (writing from a € perspective).
For years now, the European markets (and elsewhere) have seen a constant drop in yields, which ended in sovereign bond yields deeply in negative territory, with some corporate bonds trading at negative yields too. The process carried all fixed income assets along for the ride as investors looked at lower rated or longer maturity bonds which in turn saw prices rise, compressing yields further. Records were broken, relative value lost its shine and liquidity became trickier as everyone ultimately ended up with very similar positions. From time to time, we had disruptions that saw the compression process take a breather, but quickly the longer term trends would prevail.
The 10-year Bund yield hit a record low of -0.14% in late September last year and earlier in the month IG credit saw its yield drop to just 0.79% while HY was as low as 3.64%.
But since then the ever falling yields trend has reversed. Bund and sovereign yields have moved higher sharply and it is very difficult to see them revisiting previous levels, unless we hit another crisis that forces the ECB to intervene more forcefully. So far, the 10-year Bund yield has risen by around 60bp to almost 0.5% now, while IG credit has seen the yield rise by a similar amount to 1.35%. But HY has actually seen the yield drop further to a record low of 3.53%. And we believe this is not sustainable. Not at a time when yields are moving higher and investors who moved constantly lower in the ratings scale in search for yield may start to fill their targets with better-rated paper.
Now in our Outlook 2017 we argue that the first half of the year is set to be a challenging one on the back of potential disappointments with the new US administration, rising rates, a heavy new issue calendar, and particularly rising political risk. We believe that the IG cash market is set to widen by around 45bp from current levels, but the HY cash market should come under even more pressure and widen by more than 200bp.