Summary:
Spreads generally compressed again this week, with the exception of CCC. In HY, B and BB were down 8 bps and 10 bps, respectively. CCC was up a very meaningful 45 bps. In IG, all ratings categories were effectively unchanged. As we have noted, spreads are historically tight, and not insignificantly due to a demand / supply imbalance. But looking at the fundamentals, generally speaking at this point companies are in good shape, and if we look at US investment grade companies, as an example, we are not seeing any cracks in the facade as it relates to balance sheets. We are not seeing defaults pick up.
We know that on a fundamental basis spreads are tighter than they should be. For example, for B rated HY at circa 350 bps, that equates to a forward implied default rate of about 3.5% when the trailing 12-month default rate is closer to 4.5%. However, it is the technicals, with a structural excess demand and particularly in the HY market. And that does not look like changing anytime soon. For example, looking at the bond auctions this week in both the US and Europe, all issuance of note was characterised by very significant oversubscription. And this comes in a week that, for example, in Europe was the biggest on record.
As we noted last week, there is a mountain of money going into new issuance. In recent weeks, US and European companies have raced to issue debt looking to seize on the risk on mood in markets after the easing of US and China trade tensions.
Figure 1: Australian Swap to Bond Spreads
Figure 2: ITRAXX Australia – CDS Index
