The spread on U.S. high-yield corporate bonds widened to a one-month peak as a spike in coronavirus cases raised alarm for investors.
While the measures taken by the Federal Reserve and U.S. Treasury have done much to alleviate the stresses in key measurements of the health of financial markets, volatility persists in high-yield credit and equities.
The high-yield spread against U.S. Treasurys rose 49 basis points from June 23 to June 29, hitting 652 bps. While this is still a long way down from the peak of 1,087 bps on March 23, the spread has reversed only 59.6% of the widening experienced during the initial panic over the pandemic.
"There has been more two-way price action in credit over the last month with the recent rise in covid-19 cases in several U.S. states is impacting confidence," Jim Reid, multi-asset research strategist at Deutsche Bank, said in a research note.
"We think credit is following equities again since the Fed became the buyer of last resort and positioning is light in equities which helps the technicals of all risk assets. So we expect tighter spreads in the third quarter," Reid wrote.
The concern over rising cases is also apparent in equities as the Chicago Board Options Exchange's volatility index — better known as the VIX — remains elevated. The measurement of expected volatility in the S&P 500 was 30.4 on June 30, down slightly from 31.4 on June 23. Having hit an all-time high of 82.69 on March 16, the VIX had dropped to 24.52 by June 5, but the rise in U.S. cases has prevented the index from returning to pre-pandemic levels below 20.
The volatility did not extend to the U.S. investment-grade bond universe in the last week. From June 23 to June 29, the spread widened, but by just 5 bps. The spread has reversed 79.9% of the spike it experienced during the peak of the turbulence in financial markets.
The Fed's decision to start buying corporate debt put a lid on yields, with the combined $750 billion of buying power representing 42% of the outstanding universe of investment-grade corporates with maturities of five years or less, according to strategists at Wellington Management.
"We think it effectively short-circuits the process of liquidity risk becoming solvency risk for stressed companies," strategists Daniel Cook and Nanette Abuhoff Jacobson at Wellington Management wrote in a research note.
Emerging market corporate spreads followed a similar path, rising 5 bps, to 411 bps, in the week to June 29.
"With U.S. rates anchored by the Fed and the ongoing recovery in China, emerging market sovereign and corporate credit is attractive. But must be selective given the impact of the virus, especially in Latin America, and more limited policy room for maneuver," David Riley, chief investment strategist at BlueBay Asset Management, said in an email.
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 — widened slightly, from 22.6 on June 23 to 23.71 on June 30.
The leveraged loan market continued to normalize, with the percentage of the S&P Global Ratings U.S. loan index priced below 80 — a closely watched indicator of stress — dropping to 7.9% on June 29 from 8.4% on June 22.