With the vast array of political and economic activity throughout 2016, it certainly was difficult to keep up with the volatility in the Corporate Bond market. Brexit, U.S. Presidential Elections, monetary policies, to name a few, contributed to what was a very eventful year. So, when there is such volatility and unrest how do you keep an eye on the changing spreads and yields in the Corporate Bond Market? Using our proprietary Corporate Bond Curve data, we have taken a look at 10 year BBB1 rated Corporates throughout 2016 and found the following:
- Energy sector saw largest spread declines: Euro -72%, USD -65%, GBP -42%
- Average corporate bond spreads declined 45.6% Euro, 33.8% GBP, 38.9% USD
- Average spread differential between Euro to USD tightened 32% from 155bp to 104bp
- Average spread differential between GBP and USD tightened 49.5% from 107bp to 54bp
- Considerable spread tightening across all sectors
Looking at the chart above, we can see how the energy sector performed throughout 2016. When we consider that 2015 was extremely negative with regards to this sector and that energy spreads were at levels last seen during the financial crisis, a correction was always a possibility. The crash in oil prices to its low of $26 a barrel in February caused a sell-off in the energy sector, which caused the market to become nervous that perhaps even those companies with excellent credit health might be at risk of defaulting. However the stability provided by the oil price recovery, helped by a positive reaction to OPEC’s production cuts announced in November, and an increased investor appetite to look for yield led this sector to become the top performer in 2016.
Looking at Table 1 above, we can see the dramatic decreases in spreads across all sectors in all currencies; however, there are some nuances. One of the main drivers for spread decreases during 2016 was the decisions by the ECB (March) and UK Government (August) to extend their asset purchase plans to include corporate bonds. Following the unexpected result of the Brexit vote and the possibility of a recession as a result, the Bank of England was keen to ensure that the largest Corporations continued to borrow.
By buying these assets, the interest rates that needed to be offered to attract investors would remain low, and therefore make it easier to borrow money. The ECB’s primary reason for doing this was to look at increasing inflation and to assist the flagging Eurozone economy. However, by purchasing these assets, a floor has been put into effect under corporate bond prices, which has driven spreads lower. In the hunt for yield, investors have moved down the capital structure, looking at speculative grade securities and also moved towards USD denominated debt, which offered much more attractive yields compared to Euro and GBP, as we can see in Figure 2 below.
Other sectors that have benefitted from the asset purchasing plan are utilities and consumer staples. According to the Bank of England corporate bond sector shares, these two sectors made up 35% of total number of corporate bonds that were repurchased. Our data shows that the spreads on 10-year BBB rated GBP utilities tightened 43.9% from 141.5bp in January 2016 to 79.4bp by the end of the year. As Figure 3 below shows, spreads in 10-year GBP BBB utilities finished the year lower than Euro and USD currencies, despite an increase in the lead up to the Brexit vote. Spreads in Euro denominated BBB 10 year debt was also down 43% (151bp to 86bp) whilst U.S. denominated spreads tightened 47% (378bp to 157bp).
Spreads in BBB rated 10-year consumer staples debt, a sector that is typically sought after during times of volatility and uncertainty, tightened 47% (Euro), 35% (GBP) and 22% (USD) as shown in Figure 4 below. Given the continued uncertainty surrounding Brexit and the pace at which the U.S. will raise interest rates, this sector is likely to continue to interest investors, which could cause spreads to tighten further.
With all the volatility caused by the macro economic environment and the dramatic changes in the political environment, 2016 will not be forgotten. However, despite many worrying that spreads and defaults would continue to rise and things would get worse, particularly in the energy sector, quite the opposite has occurred. It could be argued that there continue to be some good opportunities for 2017; however, investors will possibly need to take a few more risks. The search for yield will continue, which may mean further issuance and investment into speculative grade Corporate debt. Brexit, the Trump administration, the Eurozone elections, and questions about economic growth will ensure that volatility remains during 2017, so there may be a few more bumps in the road.
1 Credit Ratings provided by S&P Global Ratings