High Yield Spreads Near Historic Lows

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Bloomberg Nov 17 20:04 · 14.7k Views

Low levels of high yield spreads have led to impressive issuance as some investors look to lock in funding at current spread levels.

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00:00 The issuance has been quite stunning from what you've seen in the market, especially given that we have not seen as many rate cuts as expected.
00:08 What is in the pipeline now?
00:11 Great question, Shonali.
00:12 So I think a huge driver of the issuance we saw this week was the low level of spread.
00:18 So a lot of spread sensitive funders, the financials for example, see spreads where they are and they want to lock in that funding.
00:24 So we did see a bit of a lag and now we're seeing those spread funders really come to market.
00:29 I think that will continue to happen,
00:31 probably less issuance from those more coupon sensitive borrowers given that yields are still a bit higher in investment grade.
00:39 We think most,
00:41 most issuers have pre funded their borrowing needs already ahead of the election.
00:46 It's incredible because you will have investors just flying into the market despite where spreads have been.
00:51 Dominic, why is
00:53 that the case?
00:53 It's yield, yield, yield, right?
00:55 Everybody's looking for yield.
00:56 It's the best yield you've had
00:58 in the last 15 years, right.
01:00 Post GFD was no yield.
01:01 So many people who were avoiding
01:04 the fixed income market because it was not guilty enough.
01:06 I'm not looking again.
01:08 And so you have a lot of inflows that have been very, very steady.
01:11 And when we talk to investors, they expect more inflows in the next three to six months.
01:15 It's incredible because you do have a few people out there still drawing caution.
01:19 Of course, the market is speaking for itself.
01:21 Do you think that there are risks investors are ignoring to chase that yield right now, Megan,
01:27 I think for now we're, we're actually still constructive on spreads at these levels.
01:32 So we're, we're basically sitting at our our spread target for investment grade to the end of the year at 78
01:38 basis points.
01:38 And I think what investors are rightly thinking is we've just passed this major risk event, the major risk event of the year, the US election.
01:45 We have results,
01:46 policy uncertainty is lower in one dimension at least.
01:50 And then I think corporates are thinking,
01:53 wow, I might be under a very friendly operating backdrop next year.
01:56 You saw that with US Empire manufacturing earlier, seeing that huge spike,
02:01 corporates assume that that that it could be a beneficial backdrop.
02:04 And then I think the second point,
02:06 November and December are very seasonally supportive for credit.
02:10 So I think for now,
02:11 the the valuations are justified as we head into the end of the year.
02:14 It's kind of an interesting comment you made a little earlier about this idea that you've seen a lot of companies refinance already.
02:20 So what does that mean in terms
02:23 of how investors chase the future supply?
02:25 If you're not getting a whole lot of it?
02:27 Do you just expect
02:29 much more money to be flowing in and and that driving spreads to be at even more narrow levels?
02:34 It's tricky because the gross number looks big, right?
02:36 Like this week, we got $50 billion of issuance in IGA.
02:39 People expected 2728,
02:41 but it was 35 billions of coupons and maturities paid back to
02:45 investors this week as well.
02:47 So you only have to 15 to absorb.
02:48 So it's not super large.
02:50 Same story next year.
02:51 You have a lot of maturities, a lot of coupons, right?
02:53 The yield have increased, coupons are larger.
02:55 So net, net, you get 2 numbers that are actually net of coupons and net of maturities next year that will be lower than this year.
03:02 So you don't need a ton of demand to keep spreads where they are.
03:06 Credit risk would you take on at this point.
03:08 So right now
03:09 simply just as Megan, we think that spreads are about right.
03:12 We're going
03:13 to go stay tight for the rest of the year.
03:15 The seasonal all this that we discussed
03:17 now
03:18 spreads, I mean reverting, right.
03:19 So we are at the tight end of all the ranches.
03:21 So if you want to bet why we are in one year and two years,
03:25 it should be wider than we are here.
03:27 The question is how long can we stay tight O four O 7?
03:30 We stay tight for some time.
03:31 Well, what widen spreads out at this juncture?
03:35 I think for us the the main tail risk is a reacceleration of inflation.
03:40 So if the Fed does have to slow down or even pause rate hikes and that Fed put is removed from the market, I think that could jostle credit spreads and we could see a widening.
03:50 But
03:51 for now, we have seen this massive easing in financial conditions.
03:54 If you look at the Fed senior loan officer survey, for example, this week, the 1st we reading in eight quarters, that's been neutral and not tightening of conditions.
04:03 So I think we have some time before that that tail risk really comes into play.
04:07 Well,
04:08 to that note, do you think conditions get even looser from here?
04:12 So what we believe is that the feds would cut once in December.
04:16 So
04:17 maybe, you know, a close call, but that's what we think.
04:19 And next year, only two cuts.
04:21 So not so much of cutting going forward.
04:23 But if you look globally, as Megan was saying,
04:26 a majority of central banks are cutting.
04:27 That's easing financial conditions.
04:29 At the same time, what does growth look like?
04:32 Our economists globally think that gross is only slightly lower next year compared to this year.
04:36 So
04:37 usually companies are doing fine in that environment.
04:39 Would you agree that you would only see three cuts into the end of next year?
04:42 And if that's the case,
04:44 why are credit markets frankly holding up so well you would expect to see more cracks with only that many cuts?
04:49 Well, our base case is we do get the one cut in December.
04:52 We definitely think it's more of a close call though and in play.
04:55 And next year, we've penciled in closer to four cuts for now.
04:58 I think the risk is we do.
05:00 See, fewer than that.
05:01 I think for now credit
05:03 is pricing in very strong fundamentals.
05:05 So as long as we get that dovish tendency and you know a continuation of cuts, eventually
05:11 investors are going to focus on earnings.
05:13 If you look at this past earnings season,
05:15 our earnings growth has surprised positively.
05:17 We've gotten investment grade plus 5% year over year earnings growth compared to 1%
05:22 expected.
05:23 So the fundamental picture is what people will focus on.
05:25 It's been very positive.
05:27 How much are you both seeing companies start to take on additional debt to fund buybacks
05:32 at that juncture?
05:33 Are investors happy with it?
05:34 Do they like to see companies paying more in interest costs in order to pay the equity holders back?
05:40 There's a huge bifurcation.
05:42 So you see some rise of animal spirits in the higher rated companies.
05:46 Tech, obviously lots of CapEx and all this has been going through,
05:49 but if you go lower in ratings, companies are very careful
05:53 take triple B minus companies year over year.
05:55 They have delivered,
05:56 they have kept CapEx flat, so they're not trying to push it here.
06:00 And the paradox of the tariffs in sense that there's an unknown going forward.
06:04 It's not clear that companies want to push.
06:05 If you look at the pipeline of M&A, it's actually lighter not than it was a year ago.
06:10 So we'll have to wait a little bit to see, you know, the clear, the cost being clear and then maybe companies push, but so far we're not seeing that.
06:16 How much are
06:17 investors really waiting for that M and a boom to
06:20 but you were just starting to talk about
06:22 leverage finance.
06:24 Is that something that people are keeping their powder dry for?
06:27 I think there is an expectation that we will have an opportunity to investors will have an opportunity to participate in M&A deals.
06:34 We do expect a a decent pick up next year for M&A.
06:38 Not only have borrowing costs come down, equity multiples in certain industries look attractive from a high yield perspective.
06:44 So I think that is something and will be an A
06:46 big opportunity next year for high yield investors.
06:49 Now 30 seconds each favorite trade at this moment,
06:53 compression,
06:54 if you look down the ratings,
06:56 actually valuations are attractive compared to the rest.
06:59 It's all the relative obviously.
07:00 And if you think about lots of the policies that we discussed with Central bank's easing further what the Trump policy is supposed to be that's going to help these companies.
07:09 I would like to, I would pitch European investment grade over U.S.
07:12 investment grade.
07:13 If you look at the European market,
07:15 you're getting about a 20 basis point pickup relative to the USI think there is
07:20 a consensus lot of bad news already priced into Europe with expectations that trade war miss
07:26 risk may weigh on,
07:28 may weigh on that region and also slower growth.
07:31 And so I think going forward that you'll see some potential even if we just have a carry environment for European markets to outperform.

High Yield Spreads Near Historic Lows

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