For the last several years, we have noted the extremely strong technical backdrop supporting investment grade (IG) corporate credit spreads. With the global rate environment extraordinarily depressed from prolonged accommodative central bank policies around the world, investors have diligently been seeking yield. In fact, with the 2016 launch of the European Central Bank’s (ECB) Corporate Sector Purchase Program (CSPP) for eligible euro-denominated corporate debt, the universe of corporate credit opportunities has become even smaller, keeping spreads very firm globally.
Admittedly, supply has been robust in recent years as issuers pursue M&A to grow and compete. But even the large new issue calendar has been met with a substantial appetite for credit. As a result, the Bloomberg Barclays U.S. Corporate Credit Index option-adjusted spread (OAS) finished last week at a rather tight spread of +104 basis points (bps). Spreads haven’t been in this context since 2014, and prior to that, you have to look back to the pre-crisis period to see these levels.
Over the past few years, we have seen tremendous appetite for U.S. corporate credit from overseas investors due to the available pick-up in yield. However, the attractiveness of U.S. investment grade corporate bonds to European investors relative to local corporate debt has decreased quite notably this year. This is displayed in today’s chart which shows the yield difference of U.S. and European IG corporates in the index versus the annualized three month forward euro hedge costs. Year-to-date hedge costs have climbed meaningfully while the yield pick-up in U.S. corporates has fallen. As a result, the appeal of U.S. credit hedged back into euros is significantly less compelling. Japanese investors have also seen the yield pick-up in U.S. corporates hedged back into yen become less persuasive.
Key Takeaway:Perhaps this trend of less attractive net yields to overseas investors will continue a bit further as the size and liquidity of the U.S. corporate market is desirable to foreign buyers. However, it seems we are very near an inflection point where the strong technicals from the overseas buyer that have helped support U.S. corporate credit are poised to wane or at least pause. Foreign purchases of U.S. corporate credit won’t collapse overnight, but as demand subsides spreads will likely face pressure.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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