US Investment Grade Credit - Near Post-Crisis Tights

Market volatility returned during the first quarter of 2018. The VIX Index (also known as the ‘fear gauge’), which is a measure of volatility in the S&P 500 Index, experienced its largest one-day rise ever on February 5 and breached 50 intra-day for the first time since 2015. Equity market volatility remained an outlier as volatility did not materially rise in any other asset classes.

Nonetheless, market risk premiums responded to this change in the environment, and US corporate credit spreads were no exception. Investment grade widened by 16bp resulting in -0.79% excess return versus US treasuries over the quarter. The widening move was contained, however. US credit still trades close to post-crisis lows. Most of the weakness was felt at the higher-beta end of the market, or in more-liquid synthetic assets.

The volatility appeared to be driven by increasing uncertainty as treasury yields rose and inflation threatened to make a comeback. Economic data, however, remained strong. Manufacturing PMIs remained strongly in expansionary territory. Inflation remained muted despite the unemployment rate sitting at new lows of 4.1%, although the prime-age participation rate notably increased over the period, indicating the potential for some further slack.

As ever, politics was an important factor for markets. The Trump administration stepped up its protectionist rhetoric, introducing a number of tariffs (which it has a high degree of latitude to push through), including many aimed squarely at China. This increased market concerns about this potentially escalating into a trade war. Concerns surrounding North Korea’s nuclear weapons program were also a factor during the summer, although this appeared to die down with news that breakthrough diplomatic talks between the US and the North Korean regime had been agreed.

Looking ahead, we have a tactically positive outlook. We are increasingly of the view that volatility may subside and will not spread to fixed income asset classes such as credit. The demand and supply picture looks tactically favorable over the coming quarter. Geopolitical risks may temper, as the North Korean threat is potentially contained and behind-the-scenes trade discussions between the US, its allies and China appear to reduce the risk of an escalating trade war. We believe that a modest overweight bias to credit risk is appropriate. Bottom-up security selection will continue to be key to driving outperformance.

Click link below to read our latest views on global fixed income and currency markets.

https://www.insightinvestment.com/globalassets/documents/recent-thinking/na_fixed_income_and_currency_review_and_outlook.pdf