Following last week’s shocking selloff in government bonds, which alarmed both investors and the White House, investors have been keeping an eye on the U.S. credit markets for indications of fractures.
President Trump retracted some of his April 2 tariffs as longer-dated Treasury yields spiked, but his threats nevertheless prompted China to retaliate, heightening worries of a U.S. recession and concerns about foreign demand for American assets.
As credit markets reopen to large firms following a brief lull, the shocks seem to be abating for the time being. However, there are still concerns because it’s unclear how Trump’s tariffs will ultimately play out and whether they would cause the economy to falter.
Scott Pike, a senior portfolio manager at Income Research + Management, stated, “We don’t think it’s the time to move down in credit,” pointing out that the credit markets’ response has so far been largely restrained.
“When the bite of the tariffs starts taking hold and starts to get reflected in the data, that’s something we will be looking at closely here,” Pike stated.
In the $29 trillion Treasury market, the majority of recent selling was focused on lengthier “risk-free” bonds and certain “basis trades.” Spreads widened as a result of the turmoil that also swept across the rest of the US bond market.
Spreads, such as Treasurys BX:TMUBMUSD10Y, are priced in basis points and at a premium over the applicable risk-free rate. Significant changes in credit spreads can be used as a real-time indicator of investor sentiment toward the markets.
Analysts at Deutsche Bank said that the latest selloff was especially harsh on high-yield “junk bonds,” but it also caused larger spreads in other bond market segments.
Selling has impacted auto bonds and other cyclical sectors of the economy more severely than broader bond indexes indicate. According to Mike Sanders, head of fixed income at Madison Investments, both the credit and stock markets have mostly stayed away from levels that indicate severe tariffs or an impending U.S. recession.
“I think the worst outcome for tariffs is pretty much over,” Sanders stated. “But we still need to deal with consequences of these tariff decisions.”
Tariff unrest
As Trump’s trade war intensified, the U.S. stock market saw a correction, with the S&P 500 index SPX closing Wednesday around 14% below its February record high. It has escaped entering a bear market, which is characterized by a decline of at least 20% from its previous peak, in contrast to the Nasdaq Composite index COMP.
On April 7, spreads in high-yield bonds surged to 460 basis points above Treasurys, a nearly two-year high, before reversing course. A recent top of roughly 120 basis points was reached by investment-grade spreads.
Sanders of Madison Investments stated, “There has been a lot of volatility, but I don’t see a lot of really negative outcomes getting priced in.” He believes that while Trump may use his 90-day global tariff freeze to sever some trade agreements, high-quality bonds that have recently yielded around 5% should be a decent place to hide.
Sanders anticipates that the Federal Reserve would lower interest rates if the economy continues to enter a “self-induced” recession. This should, in principle, make existing bonds that were issued at recently higher yields more appealing to investors looking for reliable fixed income sources.
The Fed is starting to lower interest rates this year, which could provide the economy more wiggle room, as seen by credit markets. It has been hoped that Trump will compromise and engage in trade talks.
Manulife John Hancock Investments co-chief investment strategist Emily Roland stated, “I think everyone is in a wait-and-see mode still – and maybe for a while.” The “hard” economic data, such as the labor market, still shows a strong foundation, she said, despite the “soft” attitude data showing a gloomy outlook on the economy.
Major bank bonds, where spreads have increased but don’t represent elevated worries about defaults soaring in their loan portfolios or a recessionary backdrop, seem to reflect a similar sentiment.
Spreads on bonds issued by Citigroup Inc. (C), Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM), and other major U.S. banks have been rising since the year began, according to the BondCliQ graphic below.
According to Roland at Manulife, spreads on high-yield bonds that rise to 600 to 800 basis points may more accurately represent growing recessionary concerns.
“Credit spreads are kind of the canary in the coal mine,” she said. According to Roland, they will first inform you if there is a more dangerous trend in liquidity or the possibility of defaults increasing. “We’re just not there yet.”
