US corporate bond yield spreads narrowed over Treasuries on Friday, extending a two-month rally that's become increasingly reliant on economic optimism, analysts said. Investors have accelerated their shift out of US government Treasuries into corporate bonds with much higher yields this month as government bond yields have spiked to six-month highs on worries about ballooning government debt issuance and fears for the future of the US top debt rating.
The main index of US investment-grade credit default swaps tightened by around 3 basis points to about 139 basis points on Friday, according to data from Markit Intraday. But the rally of corporate bonds and other riskier assets is vulnerable if an apparently brightening outlook for the battered US economy were to turn somber again. Bond fund managers are debating just how bold investors will be in buying riskier assets if the much hoped for recovery turns out to be a mirage.
"The weakness we have seen in Treasuries has been partly a sign of supply but also of economic recovery which is a positive for both the stock market and the corporate bond market," said William Larkin, portfolio manager with Cabot Money Management in Boston.
"People are looking for that added yield, which you can get easily in the corporate bond market," he said. US investment grade corporate bond yield spreads over Treasuries have narrowed some 20 basis points so far this week, falling to 402 basis points as of late Thursday, according to Merrill Lynch aggregate data. That's down from a record 656 basis points in early December, when investors stampeded into comparatively safe Treasuries, leaving the corporate debt market paralysed.
Year-to-date, investment grade and high yield bonds have rallied back in a big way as investors' late 2008 terror has turned to incipient greed. Yet corporate bond analysts are keeping a close eye on the stock market. There, a two-month bear market rally is faltering: a potential warning sign that investors' apparently benign view of the economy may fade, quashing demand for riskier assets.
If Treasury yields' jump earlier this week became a sustained spike, that would raise borrowing costs first for homeowners and then for companies, halting the corporate bond market rally, some analysts worry. In the embattled automaking sector, a counsel for bondholders of General Motors Corp said that bondholders and the Treasury had reached a deal on new debt swap terms after discussions over the past week.
GM's 8.375 percent bonds due in 2033 last traded at 9.5 cents on the dollar on Friday, down from 11 cents on the dollar late on Thursday, according to MarketAxess. Through its support to securities markets, financial institutions and companies, the US government "is trying to keep the economy going, though these spending programs, but we will have a very active Treasury auction (calendar)," said Larkin.
"The Treasury selloff over the past few days has been a warning light that this could slow down the recovery," he said. Corporate bonds have started to price in expectations that the default rate will not be as high as in the Great Depression, so any relapse of the enfeebled economy could worsen the outlook for companies and punish corporate debt prices.
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