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Assessing high yield bond credit spreads so far in 2014

Surbhi Jain

Credit spreads: A fixed income investor's must-know guide (Part 5 of 6)

(Continued from Part 4)

High yield bond credit spreads

As we discussed in parts 2 and 3 of this series, credit spreads tighten with improvements in economic conditions. The U.S. economy is recovering from the 2009 recession, and macroeconomic indicators are positive as far as the country’s economic growth. Investor confidence, which had plummeted, is regaining.

So credit spreads are tightening for corporate bonds, as the economy is showing signs of improvement, and the macroeconomic outlook is positive. To read more about the U.S. macro-economic outlook for 2014, read the Market Realist series Must-know 2014 US macro outlook: The crack in the debt ceiling.

The iShares S&P 100 ETF (OEF), which tracks the large-cap equities of companies like Apple Inc. (AAPL) and Exxon Mobil Corp. (XOM), serves as a good indicator of the course the U.S. economy is taking.

Credit spreads for high-yield bonds have shown a declining trend.

The chart above depicts how credit spreads for ten-year BBB-rated high yield bonds have evolved since the beginning of the year. The ten-year BBB spread is the premium (or excess return) that a ten-year BBB-rated bond pays over the ten-year Treasury bond yield.

Quantitative easing, the massive bond-buying program by the Fed—through which the government invests substantial funds in purchasing its own Treasury securities—has led Treasury rates to an all-time low.

The capital market has become yield-thirsty on account of Treasury yields being at an all-time low. So investors are diverting their investments towards high-yield bonds in search of better risk-adjusted yields.

Through the recent tapering initiatives, through which the Fed’s gradually reducing the amount of Treasury bonds and mortgage-backed-securities it buys, yields on Treasury bonds should show an uptick. The taper is an indication of improvement in the economy, raising expectations for corporate profitability. This is precisely why the high yield bond spread curve (in the chart above) was reversing its trend in early March.

The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK) are popular ETFs in the high yield bond category.

Continue to Part 6

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