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Will Midterm Elections Affect Corporate Credit Spreads?

With midterm elections upon us and Republicans securing majorities in the house and senate, what impact will this have on the economy and corporate credit? Now that QE has ended and signs of the economic growth are holding steady, rates are looking to move up sometime in 2015 but opinions on when vary widely. With one party controlling congress can we expect to see that structural reforms needed to sustain the monetary policy moves made by the Fed? Let’s take a look at how corporate z-spreads, the spreads over the treasury curve, have moved over the past year for an indication on what the corporate market is pricing in.

Looking at the U.S. investment grade spreads from 11/4/14, 8/4/14 (3 months ago), and 11/4/13 (1 year ago) we can see changes that have occurred over time. In chart 1 we can see spreads have tightened since last year but recently widened compared to 3 months ago. Yields in this space have been driven down due to a combination of low interest rates, high issuance, and global growth concerns. Spreads have recently widened due to movements into riskier asset classes within the last month. 

          

Looking next at U.S. high yield in chart 2, we can see that the curve has steepened, with short term spreads moving down and longer term spreads rising. The market is signaling credit over the short run is healthy but the market does have some concerns within high yield over a longer credit cycle.  

           

In a Republican controlled House and Senate, typical expectations would be for pro-business reform. Lighter taxation and less regulation are policy shifts that come about with Republican leadership. Some sectors that may be most impacted will be energy and healthcare with a spotlight on the Keystone Pipeline and the Affordable Health Care Act. In addition, it is important to keep in mind fundamentally EPS for the quarter is expected to grow around 7-8% YoY in the S&P 500. If fundamentals hold and the environment becomes more pro-business we would want to see if z-spreads continue to tighten as a result.

You can find more details here on sector based curves in the Q3 2014 edition of Fixed Income IQ: Corporate Credit Markets North America.

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Similar trends will be discussed in the upcoming webinar Junk or Hunk: Where Does High-Yield Go From Here?

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