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High yield bond spreads had recouped most of their Q4 widening before the market sold off in May, sending spreads wider. Despite strong year-to-date returns, spreads as of June 30 are only roughly 50 bps tight to 5-year averages and 40 bps wide to where they were 12 months ago.1 We believe that spreads will remain near their current levels.

As we discussed in our credit fundamentals and return outlook sections, we anticipate the majority of credit returns for the rest of the year to be driven by carry (income return). We do think it’s possible to see potential upside to this scenario if the Fed cuts rates as expected and economic growth remains steady.

Similar to high yield, senior secured loan spreads have fallen from their Q4 2018 peak but remain wide compared to their recent tight in September 2018. While the market has fully recouped its Q4 2018 losses from a return perspective, global trade tensions, possible slowing growth and investor outflows as a result of changing Fed rate expectations have contributed to the market being unable to fully recover from a spread basis.

We believe current spread levels, which are slightly tight to 5-year averages, are reasonable for the current macro outlook. Low defaults and slow but steady growth support a spread environment tighter than “average.” Whether the loan market can maintain its balance in the context of increased retail outflows, which could cause spreads to rise, bears monitoring.

Another interesting dynamic to watch is the yield gap between senior secured loans and high yield bonds, which turned negative for much of April for the first time since December 2008. Given that loans are typically senior in the capital structure and secured, they have historically traded with a lower yield.

While the negative turn may indicate that loan yields, and thus spreads, have room to contract, we believe there are other factors impacting this relationship. In particular, the increased issuance of lower-rated loan borrowers has pushed single-B borrowers to nearly their highest overall composition of the market on record. This shift in composition, which has not been seen in the high yield market, may be mostly responsible for the widening of loan spreads in relation to high yield.

1 Bloomberg.

All data as of June 30, 2019, unless otherwise noted.

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