Credit quarterly outlook: Can spreads ever widen again?

Suffice it to say, credit has been remarkably firm of late despite a host of potential obstacles. Political turmoil in Europe, extreme rate volatility, geopolitical escalations, and the US Presidential election (to name just a few) might reasonably have been expected to trigger material uncertainty and risk aversion. However, any such episodes were typically short-lived and ‘buying the dip’ was the correct response every time.

With hindsight, we’ve been a little too cautious this year. Our base case of slowing growth, ongoing disinflation and easier monetary policy supporting credit has indeed played out. But, given the plethora of risks on the horizon, we didn’t quite imagine spreads would end the year at, or close to, the tights of the century.

So what did we miss? The power of yield!

While credit investors typically assess value from a spread perspective, it has become increasingly obvious that total yield is a far bigger driver for many market participants. This gives rise to something of a ‘valuation conundrum’ where tight spreads meet attractive yields. For now at least, the lure of higher yields trumps compressed spread valuations and demand for credit remains relentless.

This brings us back to the very ‘clickbait’ title of this piece. Yes, spreads can still widen, but exactly when and why remains uncertain. While we struggle to get excited about spreads at current levels, we also find it difficult to be too negative given the overwhelming demand in the market. Fortunately, as global credit investors, simply being long or short risk is not the only game in town. We expect to derive our alpha from other levers in the near term, while maintaining ample ‘dry powder’ to exploit any volatility in coming months.