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US high-yield spreads rewiden; interbank stress continues to ease – risk monitor

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US high-yield spreads rewiden; interbank stress continues to ease – risk monitor

Measures of uncertainty in equity and interbank lending markets fell in the past week and U.S. investment-grade yield spreads plateaued below their peaks as the Federal Reserve liquidity measures continued to sooth the financial system amid signs that the coronavirus pandemic is peaking and social distancing measures can be eased.

However, high-yield bond spreads widened and recovery in U.S. loans and emerging markets stalled as investors contemplated the risk of defaults while economic growth continues to crater.

Bank stress

The Libor-OIS spread — a measure of stress in the banking system — continued to narrow over the past week. The widely followed metric measures the difference between the three-month dollar London interbank offered rate, or Libor, the average cost for banks to borrow from each other, and the overnight indexed swap rate, or OIS, which usually stays close to the central bank's key rate.

The spread fell to 58.65 on April 29, the lowest level since March 11, continuing its retreat from a peak of 138.68 on March 27, as banks demand less of a premium to lend to each other. It remains above the 37.50 level of March 6 before it accelerated higher.

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The VIX — a measure of volatility on the S&P 500 index — also flattened further in the last week. At 33.29 on April 27, the so-called fear index was at its lowest level since Feb. 26, reflecting increased normalization in U.S. equities after volatility reached an all-time high of 82.69 on March 16.

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Investment grade corporate debt markets have also plateaued with spreads relatively stable at levels lower than the peak of the market panic in mid-March, but still significantly higher than before the coronavirus-related lockdowns began.

The ICE Bank of America U.S. corporate index option-adjusted spread was 234 basis points on April 27 having been largely unchanged over the previous two weeks.

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The U.S. high-yield complex was more volatile with the spread returning above 800 basis points on April 24 having fallen as low as 731 basis points on April 17.

"Our global portfolio managers currently prefer high quality investment grade, especially discounted new issues, to high yield bonds and are avoiding 'fallen angels' likely to be downgraded to high yield," Andrew McCaffery, global chief investment officer at Fidelity International, said in an email.

"Investment-grade has less leverage than high yield and its risk-reward ratio during a recession is often more attractive, given the greater transparency around investment-grade default risk."

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The normalization of the U.S leveraged loan market also seems to have stalled.

The percentage of companies priced below 80 on LCD's U.S. leveraged loan index rose from a low of 17% on April 17 to 18.44% on April 23 before dropping back to 17.63% on April 28. In the beginning of March the total was just 4.7%.

LCD is an offering of S&P Global Market Intelligence.

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The emerging market debt complex also remained elevated, with the spread on investment grade bonds ending April 27 at 541 basis points, largely unchanged over the previous two weeks, but up from the 250 basis-point level before the crisis. The spread has fallen from a high of 641 basis points on March 23.

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