Tuesday, March 23, 2023
While most market participants have been (rightly) focusing on the sell-off in the Treasury markets this year, U.S. corporate credit markets have sold off as well. Corporate credit markets, as defined by the Bloomberg Barclays U.S. Corporate index, are down over 5% for the year, which is on pace for the second worst start of a year since 1980. While the negative price performance has been meaningful this year, we don’t think it is a harbinger of things to come.
To take advantage of low interest rates, shore up balance sheets and extend maturities, corporate CFOs issued a record amount of debt last year. By doing so though, those corporate borrowers increased the interest rate sensitivity of those securities. In fact, coming into the year the interest rate sensitivity of the corporate credit markets (as measured by duration) had never been higher—higher than even the Treasury index. Interest rate risk was and is a bigger concern for us than credit risk.
“While there is that saying that credit tends to lead equities, we don’t think the sell-off in the credit markets will spill-over into other markets,” according to LPL Financial Chief Market Strategist Ryan Detrick. “We believe the sell-off is related to rising interest rates reflecting better growth prospects, not rising credit risks.”
As we can see from the LPL chart of the day, the increase in yields for credit issuers is in line with what has happened in the Treasury markets (top chart). The solid orange and blue lines represent current interest rate levels for the U.S. Treasury yield curve as well as the BBB corporate yield curve, respectively. The dashed lines represent where those same curves began the year. As shown, both the U.S. Treasury curve and the BBB corporate curve have moved up in unison this year. Moreover, the compensation for taking on corporate credit risk (bottom chart) has remained well behaved. At the beginning of the year, the option-adjusted-spread (OAS) or the yield premium over Treasuries was slightly over 1.20%. As of close Friday, March 19, OAS had decreased marginally to 1.17%. If the market had credit concerns, we would see an increase in OAS—not further tightening. Thus, the sell-off in the credit markets has been an interest rate story and not a credit loss story, in our view.
We remain neutral on corporate credit and we continue to recommend a blend of high-quality short-to-intermediate bonds in tactical portfolios. Compensation for longer-maturity, rate-sensitive bonds remains unattractive, in our view. We still see incremental value in corporate bonds over Treasuries, but credit spreads have little room for further tightening.
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