U.S. credit spreads unlikely to tighten much further, says UBS

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NEW YORK (Reuters) – The U.S. corporate bond market has made a dramatic recovery from the early stages of the coronavirus pandemic, but it is unlikely to improve further in the near term, according to UBS Group (S:UBSG) analysts.

Spreads on U.S. corporate debt – the premium investors demand to hold the riskier credit over risk-free Treasuries – have narrowed dramatically since both the investment grade and high-yield ICE/BofA indexes hit 11-year lows on March 23. <.MERC0A0> (MERH0A0)

That recovery is primarily attributable to the U.S. Federal Reserve’s unprecedented intervention into credit markets, UBS said, enabling U.S. companies across the credit spectrum to continue borrowing in the public market. That support has been priced into the market at this point, leaving U.S. credit spreads with little room left for improvement until financial conditions change dramatically.

“The easy part of the post-pandemic spread tightening is largely over for most credit risk assets. With the large monetary and fiscal stimulus already largely priced in, we believe the grind tighter in spreads will be much slower, if at all,” wrote Barry McAlinden, fixed income strategist at UBS Wealth Management.

The report by McAlinden and other UBS analysts, released on Thursday, also attributed the quick recovery in credit markets to a slower and more forgiving pace of downgrades by credit rating agencies and to the better financial health of Corporate America going into the coronavirus pandemic than in previous crises.

UBS favors investment-grade credit over high yield.

Deleveraging or responsible increases in leverage are more likely to occur among companies with an interest in preserving their investment-grade credit ratings. Such creditor-friendly behavior could narrow spreads further.

While the Fed’s action has restored liquidity across the asset class, its bond-buying initiative focuses primarily on investment grade credit, a further boon.

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