WEEKLY UPDATE
As the Federal Reserve shifted the fixed-income markets back into easing mode this week, the credit markets finally saw some respite from the relentless bid of the last few months. Although aggregate spreads have barely budged, the higher beta names have definitely had a more offered tone to them in recent trading sessions and there were bid lists a-plenty to add some secondary supply to the robust calendar of (mostly) high-yield deals. With a change in Fed bias, $58 billion of Treasury supply, and a flatter yield curve for investors to contend with, it was not surprising that spread markets needed to regroup. Although we do not expect the pace of the spread tightening that has been seen year-to-date to continue, we maintained our overweight allocation to corporate spread product going into May. Our rationale was nicely emphasized by the FOMC in the statement they released on May 6, detailing their concern about a substantial fall in inflation. With the Fed clearly still in stimulate mode the level of corporate bond spreads needs to be viewed in the context of interest rate policy settings.
The contraction in corporate spreads has enabled a reduction in company borrowing costs that is a key part of the Fed's agenda in combating the current millstone around the neck of this economic recovery is the lack of business investment. It is businesses that need to come to the economic party and the continued provision of cheap funding via the capital markets is the Fed's way of extending them an invitation. Tight corporate spreads are not an end in themselves; they are a means to an end. The end is increased business spending. We haven't seen it yet, and if the tone of the CEO's who just regaled us with many hours of conference calls discussing first quarter earnings is anything to go by, we won't necessarily be seeing it any time soon. Which means those skinny corporate spread levels have not yet fulfilled their purpose. So we remain comfortable with an overweight allocation even though we are obviously in the mature phase of this spread rally.
As we can no longer expect spreads to continue to run as they have, we would increase focus on names that have lagged the overall move to see if underlying credit trends at those companies warrant an increase in exposure, maintain focus on potential M&A moves the second half of the year, look for pricing opportunities in the short end around the new three-year treasury note, look to trade down the capital structure in better quality names where spreads are exceptionally tight and consider opportunities in off-the-runs where there is adequate compensation for illiquidity.
Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.
