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Corporate spreads narrow as investors bet on US fiscal help – risk monitor

Appetite for risk improved in the last week as the prospect of future fiscal support from a potential Democrat-controlled White House and Congress encouraged investors to buy up U.S. corporate bonds as even as coronavirus cases rose in Europe and the U.S.

The ICE Bank of America U.S. investment-grade corporate bond spread versus Treasurys narrowed by 6 basis points between Oct. 5 and Oct. 12, to 134 bps, the lowest level since Sept. 2. The spread has reversed 89.3% of the widening experienced in March when the unfurling pandemic sent financial markets into turmoil.

"The notion that the U.S. will soon deliver another round of sizable fiscal stimulus due to a Blue Wave Democratic control of White House and Senate, and possible increase in House seats is likely allowing investors to look through the current fiscal cliff, White House antics and even a contested election," JPMorgan's cross-asset strategy team, led by John Normand, wrote in a research note.

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The more favorable outlook for risk assets was also apparent in the U.S. high-yield market, with the spread declining 26 bps between Oct. 5 and Oct. 12, to 492 bps, its lowest level since March 4. The spread has reversed 81.5% of the March blowout.

"The combination of brighter economic prospects, receding risks from COVID-19 and continued policy support, has led us to take a more positive view towards risk assets," Michael Grady, head of investment strategy at asset manager Aviva Investors, wrote in a market commentary. "We prefer to express more risk in credit markets, with an overweight view in global high yield and U.S. investment grade credit."

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U.S. companies have taken extensive measures to boost liquidity, with public investment grade-rated companies boosting their cash ratios to an average of 34.4% in the second quarter, up from 18.6% at the end of 2019, after historically high levels of bond issuance.

Non-investment-grade companies' cash ratios averaged 51.8%, up from 28.1% in the first half of 2020.

"We view another round of widespread pressure on corporate liquidity similar to the episode in March of this year as unlikely, given the large magnitude of pre-funding and liquidity raising that has been accomplished over the past several months," Amanda Lynam, credit strategist at Goldman Sachs, wrote in a research note.

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The emerging market corporate bond spread was squeezed by 11 bps between Oct. 5 and Oct. 12, to 339 bps, a one-month low.

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By contrast, the CBOE Volatility Index suggests U.S. equity investors remain twitchy. While the VIX was down from 29.5 on Oct. 6 to 26.1 on Oct. 13, the "fear gauge" remained elevated by historic levels.

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The Libor-OIS spread, a key risk indicator for the U.S. banking sector measuring the difference between the three-month dollar London interbank offered rate and the overnight indexed swap rate, was 13.5 bps as of Oct. 13, up from 13.1 bps on Oct. 6.

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In the leveraged loan market, the share of issues priced below 80 cents on the dollar, a closely watched indicator suggesting a company is more likely to default, fell to 4.9% on Oct. 9 from 5.0% on Oct. 5. Oct. 12 was a holiday in the loan market.