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A Widening of the US Treasury-US Corporate Bond Spread

Jun 20, 2018

The US Treasury yield curve is flatter now than at any point in the last decade. The US Fed has already raised interest rates twice this year, and indications from their June meeting suggest that there may be two further hikes in FY2018. Fed Funds futures imply there is an 81.2% chance the Fed raises rates at their September 2018 meeting, and a 91.8% probability of a rate hike during their December 2018 meeting. Rising trade and geopolitical risk have caused the US Treasury curve to flatten further as bond market sentiment reflects a cautious stance to future broader market risks.

 

 

While the US Treasury yield curve is flattening significantly, the US Corporate Bond yield curve, which flattened somewhat, is materially steeper than the treasury curve while moving upward from 6 months and 12 months prior.

 

 

It is interesting to note that the spread between the US 10-year bond and the generic 10-year investment corporate bond (as measured by Bloomberg’s USD US Corporate IG BVAL Yield Curve) is currently 1.38%. This 1.38% yield spread is 18.0 basis points wider than it was in December 2017, and 10.0 basis points wider than in June 2017.

 

     *Investment grade bond yield source: Bloomberg -- USD US Corporate IG BVAL Yield Curve

As can be seen in the graph above, the spread between the US 10-year treasury has widened significantly over the previous 12 months. A widening spread, normally, is indicative of negative investor sentiment towards the long-term outlook for corporate credits. A wider spread also signifies that in the long term, investors require larger risk premiums when buying longer duration coupon credits. Why does it appear that investors are seemingly more bearish towards the corporate credits as a long-term investment? There may be numerous factors.

US corporations have taken on a significant amount of “risky” long-term debt in recent years, with debt of the U.S. BBB rated 10-year-plus index more than tripling to $878 billion from $235 billion 10 years ago. Debt laden firms require more capital to service what they owe, and thus pose potentially greater credit risk, particularly as interest rates rise.

Another non-corporate risk to consider are geopolitical and economic risks that may threaten the profitability of US corporations after considering the one-time base effect of the recent reduction in taxes. Escalating global trade tensions and mounting political uncertainty have dampened investor sentiment regarding the long-term outlook for corporate profitability.

While the US Treasury curve tends to receive more attention from investors as gauge of the health of the US economy, the corporate yield curve is also an effective measuring point of investor sentiment and should not be ignored. A steepening corporate debt yield curve may signify investor expectations of a deteriorating environment for US corporations in the long run.

US Treasury Spreads

Now: 6M Prior: 12M Prior:
10YR-30YR Spread: 0.13% 10YR-30YR Spread: 0.34% 10YR-30YR Spread: 0.62%
5YR-10YR Spread: 0.13% 5YR-10YR Spread: 0.23% 5YR-10YR Spread: 0.42%
2YR-10YR Spread: 0.35% 2YR-10YR Spread: 0.57% 2YR-10YR Spread: 0.85%
2YR-5YR Spread: 0.22% 2YR-5YR Spread: 0.34% 2YR-5YR Spread: 0.43%

US Investment Grade Bond Spreads

Now: 6M Prior: 12M Prior:
10YR-30YR Spread: 0.23% 10YR-30YR Spread: 0.39% 10YR-30YR Spread: 0.59%
5YR-10YR Spread: 0.58% 5YR-10YR Spread: 0.64% 5YR-10YR Spread: 0.79%
2YR-10YR Spread: 1.12% 2YR-10YR Spread: 1.23% 2YR-10YR Spread: 1.45%
2YR-5YR Spread: 0.54% 2YR-5YR Spread: 0.59% 2YR-5YR Spread: 0.66%