Risk markets have rallied strongly in the past week on the heels of the election. Aside from anticipated policy changes, the decisive nature of the outcome and avoidance of a prolonged and contested decision may have supported the rally. Banks and energy provided the most positive reaction in credit and equities while utilities have been underperforming.1 Investment-grade (IG) corporate credit spreads tightened meaningfully late last week and set year-to-date tight spread levels at a 74 option-adjusted spread (OAS).2 In fact, spreads are at levels not witnessed since the 1990s.3
Following this market reaction, the question becomes — how low can we go in spreads? As we head into the close of 2024, there are several items to consider. First, there has historically been a slight seasonal effect at this time of year. Today’s Chart of the Week highlights the average IG corporate spread change by month. It is important to note that November and December, on average, have shown strong performance with supply that is typically light. Additionally, some of this year’s supply may have been pulled forward ahead of the election, leading to possibly even less issuance into year-end and a stronger technical.
The last time spreads widened in December was in 2018, during the Federal Reserve (Fed) rate-hiking cycle.4 With the Fed clearly in an easing mode (though the pace could slow), this would also support the argument for firmer spreads. The higher-rate backdrop will likely keep spreads firm with all-in yield buyers stepping in on any back-up.
Demand for corporate credit remains robust.5 Cash inflows have been steadily strong for the year, with no change to the pre-and post-election pace. Likewise, the overseas bid for U.S. corporate bonds has only grown as hedging costs have declined. Further Fed rate cuts will continue to reduce these costs.
Key Takeaway
Current spread levels may give investors pause to expect further improvement in corporate credit. With earnings season nearly complete, corporate fundamentals are in good shape and there are strong points to be made for spreads to continue to grind tighter. For the remainder of 2024 and into early 2025, absent a major geopolitical event, the path of least resistance for spreads seems to be tighter.
Sources:
1,2,4Bloomberg
3Reuters – Relentless U.S. Credit Demand Seen Driving Second Quarter Rally; 4/1/24
5J.P.Morgan, EPFR
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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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