“Interest rates simply rose too fast, and for now we think the rotation out of bond funds will contribute more spread widening,” analysts led by Mikkelsen wrote yesterday in a report. If yields continue to increase, “we could see massive outflows from high-grade bond funds and a much more disorderly rotation with significantly wider credit spreads. This scenario remains clearly the biggest risk to high grade this year.”
Investment-grade debt tracked by Bank of America Merrill Lynch has lost more than 6 percent since May 2, wiping out almost a year of gains as concern mounts that the Federal Reserve will pare stimulus measures that bolstered credit markets and pushed yields to a record-low 2.65 percent last month. Relative yields have widened 25 basis points, or 0.25 percentage point, in the same period to a spread of 172.
The U.S. 10-year yield climbed to 2.58 percent at 11:59 a.m. in New York, up from a record-low 1.379 percent set on July 25, 2012. The five-year average is 2.75 percent.
While the Bank of America strategists are “long-term bullish on credit and remain strategically overweight,” they recommend buying credit-default swap protection “until we get comfortable with the coming acceleration of outflows,” according to the report. “The recent sell-off and any further weakness only work to make for more attractive entry points from the perspective of long-term, patient, investors.”
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