Credit – Higher Yields, Heightened Volatility

June 2019

Risk-off delivered during May, with the 10-year U.S. Treasury yield falling 37 basis points during the month to close at 2.14%, its lowest level since September 2017. The Bloomberg Barclays U.S. Treasury Index climbed 2.3% in May on its way to a 4.2% year-to-date return. Credit spreads widened during the month, and at the start of June were back to levels seen in late January. The Bloomberg Barclays U.S. Corporate Index outpaced the U.S. Corporate High Yield Index by 2.6% during the month. Year-to-date through May, the U.S. Corporate Index posted a 7.2% gain, while the U.S. Corporate High Yield Index climbed 7.5%, surpassing the Aggregate Bond Index’s respectable 4.8% return.

With the rally in less-risky bonds in May, emerging market debt surprised to the upside, posting a positive 0.6% return on its way to generating a 6.5% total return year-to-date. Headwinds from trade and relative U.S. dollar strength may hover over emerging markets near-term, but we continue to view emerging market debt as an attractive diversifier for fixed income portfolios, especially given low or even negative sovereign yields in global developed markets, but exposure must be sized appropriately.

While credit spreads exhibited signs of stress during the month, we wouldn’t characterize what took place as a rush to the exits. Broadly speaking, moves across the credit spectrum appeared orderly, and on an absolute basis weren’t dissimilar to what occurred in late January 2018. Investment-grade spreads widened out 20 basis points during May versus 25 basis points in early ’18, while high yield spreads gapped out 72 basis points in the month, versus a smaller, albeit faster 50 basis point jump from January 31 through February 9 of 2018.

Wider credit spreads and higher yields offer greater compensation for taking on credit risk, and with monetary policy accommodative and potentially becoming even more so in the U.S. over the coming quarters, liquidity should remain supportive of credit. However, volatility akin to what we experienced in May will likely remain as anxiety remains high, and should fears of an economic slowdown/recession move closer to reality, pockets of high yield will come under pressure – this provides a good environment for active managers. Yield remains king, and fixed income investors won’t be able to shun investment-grade or high yield credit for long given paltry rates available elsewhere.

Source: Bloomberg, Factset