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Market Insights

Credit Market Themes in 5 Charts
Q3 2024
October 2024
Irvin He
Manager, Client & Product Solutions
Liam O'Sullivan
Principal, Co-Head of Client & Product Solutions

As we head into the final quarter of 2024, we have compiled five charts that we think highlight some of the key themes and opportunities we see in the current market environment. Please feel free to contact us if you would like to discuss these themes further or learn more about how we could help you meet your investment objectives.


1. The U.S. Yield Curve is Starting to Normalize

For almost 800 days, the U.S. 10yr bond yield was lower than the U.S. 2yr bond yield, the longest period of inversion on record. Now that administered rates have begun to fall, the yield curve is starting to normalize to its typical upward slope.

This decline in short-dated yields also represents a loosening of financial conditions following the tightening that occurred last year. As the relative attractiveness of longer-term fixed income improves, we expect investors to redeploy capital into longer-dated fixed income securities.

Source: Bloomberg. Data as of September 25, 2024.  


2. VIX Marginally Higher on the Year, Suggesting the Potential Underpricing of Geopolitical Risk Ahead

The VIX index, which shows the market’s expectations of 30-day liquidity, spiked in August but has since settled down to the 10-15 range. We believe the market is underpricing geopolitical and political risk given the ongoing conflicts in the Middle East and Ukraine and the approaching U.S. election. This may partly be corrected once the market turns its attention to the U.S. presidential election, but caution is warranted should any geopolitical risks come to a head in the coming months.

Source: CapitalIQ. Data as of October 4, 2024.


3. Credit Spreads Have Tightened a Bit this Year with Some Variability Along the Way

The U.S. credit market can be divided into four distinct periods based on its year-to-date movements:

  1. January-March: Interest rate cuts are taken out of the market, but robust demand for corporate bonds persists, supported by a favorable market backdrop.
  2. March-May: Credit spreads remain rangebound as inflation and economic concerns continue to weigh on investor sentiment.
  3. May-July: Spreads widen over the summer, driven primarily by the Bank of Japan’s rate hikes.
  4. July-September: The market recovers as strong fund flows push spreads tighter, reflecting continued investor interest.

Source: FRED. Data as of September 24, 2024.


4. Q4 Supply Tapering Expected to Act as a Tailwind for Credit Spreads

Year-to-date, the investment grade market has seen a lot of issuance, but strong demand has easily absorbed the supply, pushing credit spreads to historically tight levels.

Looking ahead, net credit supply – factoring in bond maturities and coupon payments – is expected to turn negative in Q4 2024, which could be another positive catalyst for credit spreads. However, this may be complicated by some risk from the U.S. political sphere.

Source: BofA Global Research, TD Securities. Data as of August 31, 2024.


5. A Sharp Increase in Large $1bn+ Portfolio Trades, Likely Driven by Fully Funded Pension Plans

As the funded status of U.S. pension plans has increased, many plans seek to increase their hedge ratio and “lock in” funded status gains, typically by extending duration in their corporate bond portfolios.

One manifestation of this is the sharp increase in the number of portfolio trades or block trades that were larger than $1bn. 1-2 per month was typical during 2023 but in September 2024 alone, we saw 9 such transactions. Market liquidity conditions continue to be robust.

Source: Milliman Inc. Data as of August 31, 2024. Funded status is shown using the Milliman 100 Pension Funding Ratio for Private Defined Benefit Pension Plans.

 

 

 

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