Macro: Sandcastle economics
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Stable Bond Spreads and Robust Issuance Make a 50 bps Rate Cut in September Unlikely
Althea Spinozzi
Head of Fixed Income Strategy
Summary:
- Corporate bond markets indicate that expectations for a 50 basis points rate cut by the Federal Reserve in September are unrealistic.
- High-yield (HY) and investment-grade (IG) bond spreads remain historically tight, with current spreads close to long-term averages.
- Stock market volatility has surged, but bond market volatility remains well below the spikes observed during recent rate hikes, indicating relative stability.
- The robust U.S. primary bond market suggests recession fears may be overstated. Investment-grade and high-yield bond issuance are at high levels, meeting strong demand.
Bond Markets Remain Resilient Amid Recent Market Selloff.
The recent selloff doesn't justify the market's expectation of a 50 bps rate cut by the Fed in September.
Credit spreads for both high-yield (HY) and investment-grade (IG) corporate bonds remain tight by historical standards. Over the past 10 years, the CDX IG 5-year spread has averaged around 66 bps, currently trading at 60 bps. Similarly, the CDX HY 5-year spread has averaged 380 bps, which aligns with current pricing.
While stock market volatility has surged to levels reminiscent of the COVID-19 pandemic, the MOVE Index, which measures implied volatility in the U.S. Treasury markets, has also risen but remains within the range observed throughout 2022 and 2023 during the Federal Reserve's rate hikes. This suggests that while equity markets are experiencing heightened uncertainty, the bond market's volatility expectations are more tempered, reflecting a degree of stability amid economic deterioration fears.
The Fed needs to witness more significant economic distress before considering a more dovish stance.
Elevated Issuance in H1 2024 Demonstrates That Tight Spreads and High Yields Are No Obstacle to Demand or Supply.
The continued smooth functioning of the primary bond market also suggests that recession fears may be overstated. Typically, a freeze in the primary market is a bad omen for bond markets, indicating that investors are highly risk-averse. However, the U.S. primary bond market remains robust. Investment-grade bond issuance has reached its highest volume since the first half of 2020 and is the second largest first-half issuance in the past decade. High-yield bond issuance in the first half of 2024 is the highest since the first half of 2021 and the third largest first-half issuance in the past ten years.This strong supply is clearly meeting demand, as evidenced by investment-grade and junk bond credit spreads, which have stayed at the lower end of their five-year trading ranges—93 basis points for investment-grade bonds and 313 basis points for high-yield bonds as of the end of July. The attractive yields, the highest seen since the global financial crisis, are likely driving investor interest. Despite being lower than their peaks in 2022-2023, current corporate bond yields remain considerably high compared to the 2008-2021 period, standing at 5% for investment-grade bonds and 7.8% for high-yield bonds.
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