Credit Buyers Set for a Sedate Summer as Politics Paralyzes the Market

  • ‘You’re not going to hit any home runs in this market’
  • Corporate spreads continue to narrow even with heavy issuance

Tight credit spreads and uncertainty about the Trump Administration’s economic policy have money managers bracing for low returns on their corporate bond portfolios this year.

“You need to be realistic and accept that you’re not going to hit any home runs in this market,” said Jason Shoup, portfolio manager and fixed-income strategist at Legal & General Investment Management America. “This year is going to be about hitting little singles.”

Overwhelming demand is keeping spreads the tightest they’ve been since October 2014, even with debt issuance remaining heavy.

The spread between corporate bonds and Treasuries currently is about 113 basis points, according to Bloomberg Barclays index data. And it will likely narrow further as demand continues to outpace supply, Bank of America Merrill Lynch strategists led by Hans Mikkelsen wrote in a note to clients Tuesday.

Inflows to high-grade debt mutual funds and exchange-traded funds are at a record $130 billion year-to-date, up roughly $85 billion year over year, and supply for the first five months of the year stands at $650 billion, just $25 billion above the same period last year, according to Mikkelsen.

Political Unease

While this scenario would seem to encourage risk taking and a chase for yield, credit investors have been careful because of the political unease surrounding President Donald Trump’s agenda.

“I’ve not seen a lot of that behavior because politics has kept people a little more cautious than they would otherwise be with volatility this low,” Shoup said. “In this case, folks at the moment are somewhat paralyzed and unsure where to take risk given the uncertainties on the horizon.”

In addition, the markets are becoming desensitized to the flurry of headlines about the administration and are waiting for something tangible, like a tax reform plan that could pass Congress, before responding, according to Tim Doubek, a portfolio manager at Columbia Threadneedle.

“Trump has a budget out and the Republicans hate it -- why would anybody react to that?” Doubek said. “I think anything he said or did in December, January, February would have had more impact than it does now because we had this cascade of headlines that aren’t going anywhere.”

Equity Effect

What could knock the bond market out of its slumber is a stock market correction, Bank of America’s Mikkelsen said in a telephone interview.

As an example, he pointed to what happened on May 17. After the New York Times reported that Trump had asked former FBI director James Comey to drop an investigation of former National Security Adviser Michael Flynn, the S&P 500 Index dropped 1.8 percent, the most in eight months. Meanwhile, credit spreads briefly widened before snapping back, Mikkelsen noted.

“The consensus in the market is that we need to see tax reform by year-end,” Mikkelsen said in a telephone interview. “And the more political uncertainty you have, the less likely that you get tax reform by year-end and the less likely that economic growth will accelerate.”

So it may not be long before investors lose patience with equities and opportunities open again in the credit markets. In the meantime, money managers plan to proceed cautiously, even if it means accepting diminished returns.

“You have to manage through these long regime changes, and the evolution of many different credit cycles, and there’s certain points where you’re trying not to make any big mistakes,” Doubek said. “Things are very compressed, very complacent -- this is when investors need to be satisfied with modest returns.”

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