October 4, 2018 / 5:50 PM / 2 months ago

U.S. junk bond spread over Treasuries narrows to post-crisis low

NEW YORK, Oct 4 (Reuters) - The spread between junk bonds and long-end U.S. Treasuries shrank to the narrowest since 2007 on Wednesday as the government debt sold off sharply, and analysts are closely watching to see if that could signal a coming end to the credit cycle.

The premium investors are paid, or the average spread, of U.S. corporate “junk” bond yields over Treasury debt fell to 3.16 percentage points on Wednesday, the tightest since just before the financial crisis, according to the ICE BofAML U.S. High Yield Master II Option-Adjusted Spread.

“You tend to see these levels towards the end of a credit cycle, and we’re clearly there,” said Guy LeBas, chief fixed income strategist, Janney Montgomery Scott LLC. “We’re much closer to the end than we are to the beginning.”

A bottom in spreads tends to precede recessions. A low of 2.41 percentage points was recorded on July 1 2007, five months before the start of the subprime mortgage market crisis. The spread spiked during the recession that followed the meltdown of late 2008.

Investors have been feasting on junk bonds in a low-interest rate environment for years, with most fixed income assets other than junk yielding less than the inflation rate or the dividend yield on the S&P 500. However, there has been more competition for the asset class as rates have been rising - with cash, the most low-risk investment, even becoming attractive.

“You’re definitely going to pay if you buy high-yield credit as the peak of optimism,” said Gene Tannuzzo, senior portfolio manager at Columbia Threadneedle Investments. “It is not a buyer friendly moment.”

On Wednesday, the spread was driven lower by a sell-off in Treasury bonds resulting from solid U.S. economic data, notably the 21-year high reached by the Institute for Supply Management’s non-manufacturing activity index in September. On Thursday, the benchmark 10-year government bond yield rose to its highest since May 2011.

Tannuzzo pointed to a negative correlation between high yield bond spreads and the ISM survey. When the surveys show strength in the economy, it is “usually reflected in the premium you get on high-yield bonds,” he said.

The spread between junk-rated debt and Treasuries has been falling since July, when issuance of speculative-grade debt reached its lowest in a year. The long-term trend is also downward, as the global low-rate environment has led yield-starved investors to the junk market en masse.

The price of two of the largest high-yield exchange-traded funds, the SPDR Bloomberg Barclays High Yield Bond ETF and the iShares iBoxx $ High Yield Corporate Bond ETF were down on Wednesday and Thursday.

Reporting by Kate Duguid; editing by Megan Davies and Steve Orlofsky

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