Morgan Stanley is advising investors to sell into the corporate bond market's rally, or at least put hedges in place, predicting the current "sweet spot" for risk assets may not last long. Among the biggest risks to credit are weak economic data, expected US Federal Reserve rate hikes and a drop in oil prices, the US bank's credit strategists wrote in a report Wednesday.
"Risk assets are in a 'sweet spot' for now," said the strategists.
"We are not sure how long it will last. Either the macro data deteriorates, per many of our economic forecasts, or Fed rate hikes come into play again. Both outcomes would not be great."
Other market participants are also cautious about the sustainability of the six-week rally in credit spreads - driven by a rebound in oil prices, aggressive actions and dovish rhetoric from central banks and better economic data that have helped alleviate fears of a US recession.
After hitting wides on February 11, spreads on average US high grade bonds have tightened by 48bp to T+173bp while high-yield bonds have come in by 173bp to T+714bp, according to Bank of America Merrill Lynch data.
"If this is just a bear market rally, our base case, then it would be rare to see HY and IG spreads tighten by much more than they already have," the Morgan Stanley report said.
Morgan Stanley said the macro backdrop is not as strong as some would think.
"While economic surprise indices have risen meaningfully since early February, Morgan Stanley's 1Q16 GDP tracking estimate dropped back down to only 0.6% on Monday," the bank wrote in the report.
The bank's strategists also see oil prices falling again.
"In addition to increased economic optimism, the rally in oil, arguably more so than anything else, has driven much better sentiment in credit markets," they said.
" if the dollar bull market reasserts itself, as our FX team is expecting in the medium-term, oil should again weaken."
Morgan Stanley said it is a good time to hedge long or overweight cash positions with synthetic credit, where valuations are rich compared to cash.
One investor said despite the bank's report, he might stick to buying into the rally at least for now.
"We are fighting the temptation to sell into this rally because when we look at it, there is a tremendous amount of opportunity and value in corporate credit right now," the investor said.
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