High-Yield Corporate Bonds: Tight Spreads Breed Concerns

We expect volatility to pick up, but fundamentals are strong.

May 18, 2017


This High-Yield Corporate Bonds sector report is excerpted from the Second Quarter 2017 Fixed-Income Outlook.

High-yield corporate bond spreads tightened in the first quarter of 2017, but not without some intermittent volatility. The sharp decline in crude oil prices during the first half of March led to price declines in the high-yield energy sector, highlighting the ongoing unease over the future of oil and gas producers. Non-energy sectors did not go unscathed. As the market-implied probability of a March Fed rate hike climbed from only 25 percent to over 80 percent over two weeks, spreads widened across the board, from gaming and media/telecom to retail and healthcare. Spreads have since recovered in the early part of the second quarter.

Energy Sector Is Not Yet Out of the Woods

The sharp decline in West Texas Intermediate oil prices during the first half of March led to bond prices declining in the energy sector, highlighting the ongoing unease over the future of oil and gas producers.

Energy Sector Is Not Yet Out of the Woods

Source: Credit Suisse, Bloomberg, Guggenheim Investments. Data as of 4.15.2017.

The Credit Suisse High-Yield Index gained 2.3 percent in the first quarter, making it the fifth consecutive quarter of positive returns, albeit the weakest. High-yield corporate bond spreads tightened by 22 basis points quarter over quarter, ending March at 450 basis points. All rating categories delivered positive returns, and CCC-rated bonds continued to outperform BB-rated bonds and B-rated bonds.

Tight spreads continue to reflect an optimistic outlook on corporate earnings and the promise of pro-growth fiscal policies. While earnings are improving as expected, fiscal policy uncertainty is rising. As we mentioned last quarter, we are keeping an eye on the Chicago Board Options Exchange Volatility Index (VIX index), which measures implied equity market volatility. The VIX index has persisted at what our Macroeconomic and Investment Research Group believes to be unsustainably low levels. Meanwhile, our Global CIO expects that we could see some spikes in volatility this summer. Implied volatility levels tend to be closely correlated with corporate bond spreads. Should implied volatility rise this summer, we would also expect to see some spread widening as well. This temporary spike in volatility should not be mistaken for fundamental deterioration in the leveraged credit space, however, as we continue to expect that defaults will decline through the end of the year.

High-Yield Spreads Are Highly Correlated to Implied Equity Volatility

Should implied volatility rise this summer, we would expect to see some spread widening as well. However, this temporary spike in volatility should not be mistaken for a fundamental deterioration in the leveraged credit space. We continue to expect that defaults will decline through the end of the year.

High-Yield Spreads Are Highly Correlated to Implied Equity Volatility

Source: Credit Suisse, Bloomberg, Guggenheim Investments. Data as of 4.15.2017.

—Thomas Hauser, Senior Managing Director; Rich de Wet, Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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