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Credit Traders Have No Room for Error in Dot-Com Bubble Redux

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A growing chorus of analysts is warning that high-quality company debt may have nowhere to go but down as investment-grade spreads approach levels last seen in the lead-up to the dot-com bubble.

“The best days are behind” for corporate credit, Morgan Stanley strategists led by Srikanth Sankaran wrote in a May 16 midyear outlook. “The combination of extended valuations, less favorable technicals and a slower pace of balance sheet repair suggests that credit markets have progressed to a mid-cycle environment.”

Spreads on BBB rated bonds, which account for more than half of the high-grade universe, narrowed to an average of 106 basis points over Treasuries on Monday, fueled by investor demand for the lowest-rated yet highest-yielding part of the asset class. Should spreads breach 100 basis points, it would be the first time since the dot-com era of the late 1990s.

Morgan Stanley is calling for 17 basis points of widening for U.S. investment-grade bonds through the first half of 2022, and downgraded its credit outlook to neutral.

Meanwhile, Bank of America Corp. expects another stretch of rising Treasury yields will “lead the market to price in a much faster rate-hiking cycle,” strategists led by Hans Mikkelsen wrote in a note distributed Monday. That will cause spreads to widen in the coming months as investors are pushed to either sell or sit on the sidelines.

Still, some say BBBs, the best performing tier of high-grade credit this year, may continue to enjoy a tailwind despite the tight spreads. Citigroup Inc. notes that President Joe Biden’s bailout of multi-employer pensions may spur tens of billions of dollars in demand for corporate bonds with the lowest investment-grade ratings.

Source: on 2021-05-18 12:07:30

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