The Incredible Shrinking Yield Gap: On Its Last Legs?by
Today we share two charts depicting what my be the ultimate squeeze, courtesy of bond strategist Joe Kalish of Ned Davis Research.
The first shows yield compression within corporate bonds, specifically the yield spread between Baa and Aaa bonds. Both ratings correspond to investment-grade debt, and the lack of differentiation between them (narrow spread) illustrates how the rising tide of central bank-driven liquidity has effectively lifted all boats.
The second chart shows a similar compression between high-yield bonds and the U.S. Treasury note. This may be of even greater concern. It illustrates the market's perceived difference between risk-free government debt and that of corporate America's highest-risk borrowers. The spread is at a 30-year low, which suggests traders see the least amount of difference between these two credit extremes in several decades.
Mr. Kalish believes continued global central bank support will likely keep spreads tight, but he also describes the current yield compression as "the last leg."
Tom Tzitzouris of Strategas Research Partners is even more emphatic about a coming reversal. He is urging clients to recognize the "growing inconsistency" in fixed-income markets, as low rates are beginning to stimulate the type of borrowing that ultimately creates inflation.
Bond investors have enjoyed a 30-year rally, though even "New Neutral" author and world's largest bond find manager Bill Gross at Pacific Investment Management Co. has acknowledged this may be coming to an end. As Mr. Tzitzouris indicates, unprecedented coordinated support provided by global central bankers Carney, Draghi, Kuroda and Yellen has began to have an impact. U.S. consumer prices rose by the most in 20 months during the month of May, up 2.1 percent.
Growth may still be subdued, but inflation is brewing. Enjoy the last leg.