Barbara Reinhard, CFA
Senior Managing Director, Chief Investment Officer, Multi-Asset Strategies and Solutions
In the last few weeks, we have seen notable divergences in sovereign, investment grade, and high-yield bonds globally, beginning with the French elections. What does it mean when government risk, speculative risk, and corporate risk are all being repriced in different directions?
Credit spreads are something of a barometer for the larger economy, providing insight into the market’s assessment of credit risk, investor sentiment, and overall economic health. When spreads widen, it indicates increased concern about the creditworthiness of borrowers in response to a range of factors—deteriorating earnings, increased leverage, macroeconomic uncertainty, and so forth. When spreads tighten, it indicates favorable conditions for lending and borrowing, reflecting investor confidence in the economy. Fund flows and spread movements generally go hand in hand. Tightening spreads are associated with money moving into credit, and widening spreads with money moving out of credit.
That’s assuming all spreads move in the same direction. If only. Over the past couple weeks, the French 10-year yield over German Bunds jumped to 80bp, well above its 45-60bp range of the past two years, as investors priced in the possibility of a high-spending, far-right coalition taking over France’s government.
French government bonds also rose against the 10-year U.S. Treasury, but French corporates spreads stayed broadly flat against both German and U.S. corporate debt. The Bloomberg EuroAgg Corporate Average OAS jumped only 10bp to 120bp, which seems to suggest that investors are confident that the corporate sector will by and large be able to navigate any turbulence caused by the National Assembly’s new leadership.
In the U.S., speculative-grade credit spreads (single B) stand at 295bps, their lowest since May 2007, but S&P Global’s default rate for spec bonds is forecast to rise from December 2023’s 4.5% to 4.75% by year end.
Could this be an opportunity for investors? While risks certainly remain, there seems to be something for everyone. For those in search of yield, temporary dislocations both domestically and internationally may offer potential alpha generation further up the risk curve. For those in search of mitigated risk, the economic divergence between the U.S. and EU provides opportunities for continued yield potential in the investment grade and government bond space.
Arjun Kaushik contributed to this article.