LIVE MARKETS-Are credit investors watching the wrong signal?
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ARE CREDIT INVESTORS WATCHING THE WRONG SIGNAL?
Credit investors are relying on the least useful part of the Treasury market to gauge risk, according to Wells Fargo, which says three overlooked signals now point to trouble ahead for investment-grade bonds.
Analysts Ravi Shukla and Billy Melchionni note that most credit investors judge the market by the level of Treasury yields, but that measure carries almost no predictive power. Over the past five years, the correlation between the 10-year Treasury and investment-grade spreads has averaged close to zero and flipped sign repeatedly, the bank said, adding that “the level tells you where rates stand, not what they imply for credit.”
Three other indicators that matter more are rate volatility, the policy path priced into short-term rates, and the shape of the yield curve. And all three have turned against credit.
Volatility is elevated and has been the most reliable early warning of spread widening in the data. The yield curve has flattened sharply, and though that has not yet been seen in spreads this cycle, the same dynamic, tight policy slowing growth, has historically shown up in spreads with an 18-month lag over the past three decades.
Compounding the risk, investment-grade spreads are sitting in the tightest fifth of their 30-year range, leaving little room to absorb bad news.
Wells Fargo said the combination leaves it modestly cautious on investment-grade spread risk, and it recommends using any market strength to trim exposure.
(Karen Brettell)
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