Morning Notes — Step 1: High Grade Spreads Narrow

Credit: The ECB’s vastly expanded QE plan (additional €750B on top of €250B) has successfully addressed the credit issues that followed Lagarde’s comment that narrowing credit spreads weren’t part of the central bank’s function. Her comment was a 180 degree reversal of Draghi’s consistent message on the topic. The German bund (highest regional credit)/Italian BTP (had credit concerns before Covid-19) credit spread was cut in half this morning. The narrowing spread is helping to ease credit concerns in other markets and a major reason for a healthier equity tape this morning. Note, US high grade credit spreads narrowed ~50bps to 140bps this morning.

More: Recessions occur when a shock hits a vulnerable economy. I’ve mentioned this before, but the only identifiable US vulnerability coming into this shock was record corporate debt levels at record low quality among some of the heaviest users of debt. US consumer credit was in good shape and the banking system was/is solid in the wake of 2008. High yield spreads were wider on coronavirus-related global growth concerns but the perfect storm for high yield followed the breakdown in OPEC+ talks two weeks ago. US energy companies dominate high yield debt markets and the Saudi/Russia price war caused HY spreads to widen from ~400bps to ~800bps today. The US public cruise lines are mostly BBB credit (still investment grade) but other segments of leisure have some debt that crosses into high yield status. The aforementioned ECB policy move to narrow peripheral spreads didn’t improve US HY spreads. Note the current US fiscal bill being discussed on Capitol Hill is supposed to include relief for aerospace/travel/leisure. Support for the industry should ease credit stress and could significantly narrow the HY credit spread and push equities higher. But the bigger catalyst would be a Saudi/Russia crude détente.