Are credit investors watching the wrong signal?
LQD•Wells Fargo says rate volatility, the policy path priced into short-term rates and the yield curve point to trouble for investment-grade bonds, while spreads are in the tightest fifth of their 30-year range.
1. Signals point to risk
Wells Fargo analysts Ravi Shukla and Billy Melchionni say Treasury yield levels have had almost no predictive power for investment-grade spreads over the past five years, with the correlation averaging close to zero and repeatedly changing sign. They identify rate volatility, the policy path priced into short-term rates and the yield curve as more useful indicators, and say all three have turned against credit.
2. Spreads leave little room
The bank says elevated volatility has been the most reliable early warning of spread widening in its data. The yield curve has flattened sharply; Wells Fargo says the historical dynamic of tight policy slowing growth has shown up in spreads with an 18-month lag over the past three decades. Investment-grade spreads are in the tightest fifth of their 30-year range, and the bank is modestly cautious on spread risk, recommending investors use market strength to trim exposure.
