Although we believe investors will be spared an all-out trade war, spreads* across fixed income sectors are pointing to heightened trade concerns. But should investors with diversified portfolios also be concerned?
Segments of the corporate bond market that would likely be most affected by protectionist trade policies have been hit the hardest by spread widening recently. Investment-grade corporate bonds—those of higher-rated issuers that are usually larger, more globally diversified companies less likely to have problems repaying debt obligations than lower-rated issuers—are a good example. These companies can more easily expand to new markets internationally, diversify their income streams across continents, and potentially weather economic downturns better if other global regions outperform the U.S. economy.
However, as LPL Research Chief Investment Strategist John Lynch noted, “In certain contexts, that global footprint can become a liability if newly imposed tariffs and trade barriers negatively impact U.S. firms’ foreign revenue, which could hinder their ability to fulfill debt obligations.”
Emerging market debt has been hit by trade-related concerns as well, as shown in the LPL Chart of the Day below, though the drivers are more closely tied to the dollar strength resulting from heightened trade tension. Many issuers of foreign debt use dollar-denominated bonds, and it becomes more expensive for them to service than debt when the dollar appreciates relative to their home currency.
Despite the recent escalation in trade tensions, the tariffs currently in place remain manageable, and there’s plenty of time to continue negotiations before any new tariffs under discussion would kick in. However, markets have grown concerned, evidenced by recent equity market weakness and spread-widening within certain segments of the fixed income market. For more insights into the bond markets reactions to the ongoing trade tensions please see our Bond Market Perspectives.
*A spread is the differential between a yield of a bond and the yield of a comparable maturity Treasury security. As Treasury securities have very low risk, this spread can be seen as an investor gauge of sentiment, with a higher spread indicating greater concern.
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