March 06, 2013 | By Scott Minerd
We are not at risk of seeing an immediate correction in asset prices, but we are moving into a transition period that will be characterized by greater uncertainty around policy moves. As credit spreads continue to tighten, the market will eventually anticipate a move by the Federal Reserve to normalize interest rates. Intuitively, rising interest rates should lead to widening credit spreads, but historically that has not been the case. Instead, the past several times that the Fed has ended accommodation it has been interpreted as positive for markets. This was because the Fed would only cease accommodative policies when its members believed that economic growth would continue to accelerate. Given the historical precedents, investors should recognize that a normalization of monetary policy is unlikely to immediately cause spreads to widen.
A normalization of monetary accommodation does not necessarily lead to an imminent widening in credit spreads. Since 1986, the Federal Reserve started to unwind its easing policies five times, during four of which, U.S. high yield spreads continued to ratchet in. On average, credit spreads kept tightening for nine months following the first increase in the Federal Funds Target Rate, as the strengthening economy tended to remain supportive of risk assets.
Source: Credit Suisse, Bloomberg, Guggenheim Investments. Data as of 2/28/2013. *Note: The range is generated by calculating the max/min value for all five previous cycles.
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