June 30, 2015


The credit market had a tumultuous end of the 2nd quarter, as markets responded poorly to the escalation of the debt crisis in Greece, increasing fundamental worries regarding US corporate leverage and debt issuance, and fears regarding the timing and pace of the Fed’s eventual rate hikes. Economic news has improved somewhat compared with the past several months but that has also led to trepidation about an overly hawkish Fed with the September FOMC meeting in front of us. The 10-year, which had rallied through most of 2014 and into the first quarter of 2015, sold off in the second quarter. While the 10-year yield surprised many investors to start the year, dropping to a trailing 12-month low of 1.64% in late January, yields sold off sharply in April through June, rising from the 1.86% area in mid-April all the way to a high of 2.48% in June. The sharp sell-off in Bunds preceded the US Treasury sell-off as the 10 year bunds went from almost 0 at 5 bps in April to 105 bps in June. The 10-year rallied slightly into quarter-end with the increasing fear of further Eurozone problems surrounding a Greek exit from the bloc and ended the quarter at 2.35%.


Low all-in yields at this stage of the credit cycle have continued to attract debt issuance and debtfueled M&A, while top line growth has been low. The sell-off in oil has bounced back a bit but energy related names remain fairly wide, as the market tries to figure out the longer term impact on energy-related companies of oil below $60 a barrel as we write this. Although US economic data has been more positive lately, China’s GDP deceleration has led to a sharp sell-off in Chinese equities and the Euro has sold off against the dollar for most of the quarter, reflecting the extremely easy monetary policy surrounding the ECB’s purchases and the lack of resolution in Greece. On the US Economic front, employment data was extremely strong last month with a print of +280k net new jobs in May on the Non Farms Payroll survey compared with analyst estimates of +226K, and a revised upward +221k jobs in April largely putting to bed worries of a very poor number in March. Additionally, although 1Q GDP was still negative, the revision to -0.2% annualized that was released in June was much better than the last estimated revision at -0.7% annualized.


U.S. Treasuries ended their quarterly winning streak from 2014 into 2015 with a negative 1.58% return in the second quarter after a positive +1.64% return during the 1st quarter of 2015. January was the month that contributed the most to the positive performance, partly driven by ECB’s announcement of its bond buying program.


Within high-grade fixed income, credit spreads in the Barclays Aggregate Index ended 2011 at 217 bps, 2012 at 131 bps, 2013 at 111bps, and widened to 125 bps at 2014. Spreads widened to 142bps at the end of second quarter of 2015. The year-to-date excess returns for Barclay Credit Index was negative 52 bps while longer duration credit underperformed duration neutral treasuries by 163 bps. By the end of June 2015, corporate spreads widened to 145bps from cyclical low of 99 bps in June 2014. Spreads have widened since March by 16 bps in response to heavy issuance, M&A, weakness in commodities and uncertainty from the Fed. The Barclays Corporate Index produced -0.92% return for the year ending June, erasing the gains from the first quarter, attributing negative 62 bps excess return over duration neutral Treasuries. At the sector level, spreads on Industrial credit widened 17 bps, from 136 bps of the last quarter-end to 153 bps off Treasury this quarter-end. Year-to-date, the sector produced a negative 68 bps excess return. Spreads on financial credit widened 15 bps from the previous quarter to 133 bps at the quarter-end, and the sector produced a negative 32 bps excess return YTD. Utilities also saw spreads widen by +16 bps to 137 bps and posted negative 148 bps YTD excess return due to relatively high duration (9.4 years).


Starting the year with already-tight spreads 28 bps, the agency MBS sector ended first quarter at an even-tighter spreads of 20bps and widened a little to end the second quarter at 26bps. Year-to-date the sector delivered a negative 45 bps excess return. On the other hand, ABS spreads were unchanged from 62 bps at the end of first quarter, and the sector produced a positive 35 bps excess return. CMBS spreads widened by 6 bps to 101 bps at quarter-end. June erased the year-to-date gains by ending the quarter with a positive excess return of 5 bps from 50bps through May. The Barclays Aggregate Index posted a negative 0.10% total return for the quarter.