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High Yield Spreads Hit Post Crisis Lows

2 August 2017 by Mark Holman

The continued positive performance of risk markets may have surprised a few people in July; we were certainly not expecting the levels of performance that were posted in fixed income markets. The continued hunt for yield, absence of negative surprises and confidence in the coordinated global recovery has meant that credit spreads are generally at post-financial crisis lows.

As highlighted in the graphs below, European high yield is comfortably at new lows, and in the US we are almost at the tightest level. We have long felt that as the cycle matures we would make new lows in spreads, but whether we return to the lows pre-financial crisis remains to be seen, and really depends on just how long this cycle lasts. For now though, spreads are tight and it feels as if they will stay that way. We do not see any reason to panic as tight spreads can prevail for extended periods, especially when supported by fundamentals.

Source: Bloomberg (BAML HY Index Data) – 02/08/2017

In £ high yield the spreads are a long way off the lows, and this is quite simply the Brexit premium. We have written about this several times, and would still conclude this pool of risk is worth exploring on a stock selective basis.

Source: Bloomberg (BAML HY Index Data) – 02/08/2017

Moving on to fundamentals, the economic data points towards a sustainable recovery; however, importantly, how has it impacted corporate behaviour and what has been the impact on company ratings?

Looking at upgrade versus downgrade statistics for both IG and high yield around the world, we can see a fairly rare picture, one of generally improving ratings in the year to date.

 

Europe IG High Yield Total
Upgrades 69 78 155
Downgrades 43 43 90

 

US IG High Yield Total
Upgrades 72 156 248
Downgrades 89 192 295

 

UK IG High Yield Total
Upgrades 22 17 41
Downgrades 23 12 36

Source: Bloomberg (Moody’s) – 02/08/2017

In the UK this is the first time since 2007 that the upgrade to downgrade ratio has been greater than 1. In Europe the ratio is 1.72, again the highest that it has been for 10 years. In the US it is the highest that is has been since 2014, the previous tight point in spreads.

So in conclusion, while the level of performance may have surprised us in July, the direction of performance is well validated by fundamentals, potentially with the exception of the UK where Brexit fears have left many foreign investors waiting on the sidelines.

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