US Credit Update – Tariffs Keep Materials, Industrial Sectors in Focus
Highlights from the U.S. credit markets:
- Corporates underperform as Treasuries rebound
- Investment grade continues to sag
- Consumer staples lead new issuance
- High yield lagging as Treasuries rebound
- Trade tensions keep industrials, materials in focus
Corporates underperform as Treasuries rebound
Treasuries crept higher last week with the Bloomberg Barclay’s Treasury total return index rising 0.2%. The U.S. 10yr yield fell to the bottom of its narrow range since late February but was unable to piece 2.8%. Still, Treasuries have gained 90 bps in the last month. High yield and investment-grade both sagged with riskier credits underperforming. The Bloomberg Barclays U.S. high yield index is the worst performer over the past week (-0.4%) and month (-0.6%). Leveraged loans are the only subclass of U.S. credit markets with a positive total return for the past three months.
Investment grade continues to sag
Investment grade corporate bonds have yet to find the bottom. Total returns continue to deteriorate even as Treasury yields have fallen. The Bloomberg Barclays U.S. corporate total return index is -2.6% for 2018 while Treasuries have rebounded to -1.4%. Despite the turbulence in risk markets, Treasury yields were unable to break range lows. Risk markets appear to have regained their footing this morning. Corporate bond investors have doubts about a sustained fall in rates.
High yield lagging as Treasuries rebound
High yield underperformance over the past month is right in line with expectations with Treasuries higher by 0.9%. The chart below shows normalized total return changes for Treasuries and the difference between total returns for U.S. high yield and investment-grade corporate indices. High yield reliably underperforms (negative differences) as Treasury returns rise. The recent modest underperformance might be fleeting if U.S. yields rise away from range lows and risk markets rebound.
The other highly directional theme we’ve highlighted has been utilities outperforming financials as Treasury yields fall. The next chart shows the same standardized change, 1-month total return z-scores, for Treasuries and the difference between the Bloomberg Barclays U.S. financial and utility total return indices. Longer duration explains much of the outperformance but utilities have a clearer tendency to outperform that industrials with durations nearly as long.
Consumer staples lead new issuance
Primary market activity was modest, led by Anheuser-Busch which brought a $10 billion deal. Our credit desk had the following comments on Friday:
Primary issuance this week was modest pre-Fed as ABIBB led underwritings with a $10 billion, 6-tranche deal. The deal was priced roughly a nickel cheap to the market and performed well upon freeing to trade. The 10 and 30-year tranches were among the better performers, improving 4 basis points. The 2058 maturity underperformed, backing up a basis point from its +165 pricing. The banking sector traded poorly pre-Fed with domestic names backing up +1-6 basis points. We are closing in on yearly wides set earlier this month. Yankee banks performed even worse, let by DB. The stock traded -7% Wednesday and the benchmark DB 4.875 32 backed up +10 basis points pre-Fed. ORCL announced disappointing earnings that sent the stock -9.5%. The software giant posted weaker than expected sales as revenue from its newly developed cloud computing division missed estimates. ORCL 4.125 5/45 backed up 7-10 basis points to +110/105.
Trade tensions keep industrials, materials in focus
The U.S. has been stoking trade tensions with China and other nations while more quietly offering exemptions on tariffs to allies and neighbors. Markets are racing to sort winners from losers, but Trump administration tariffs on imported steel and aluminum have captured markets’ attention. The impact of the tariffs on producers and consumers of affected metals was less pronounced last week, but has clearly affected performance in parts of the materials and industrial sectors.
The chart below shows 1-month changes in spreads to benchmark treasuries for select members for the Bloomberg Barclays U.S. industrials index. These are limited to issues of $750 million. The left panel shows spreads for copper miners (orange) have widened by 10+ bps more than spreads for comparable duration issues from iron and aluminum miners. Here the division between those benefitting from tariffs and the rest is clearest. The right panel shows changes in the spread to benchmark Treasury for aerospace and defense issues. These are among the largest consumers of steel and aluminum. Here the outcomes have been more split, but few issues have outperformed the miners benefitting from new tariffs.
The next chart shows average 1-month changes in spread to Treasuries for industry subgroups in the basic materials sector. Larger, darker circles reflect higher shares of the total par value in the index. Spreads are wider across the board, but the best performers are those with tariffs on their side. Both copper and gold miners are seeing spreads widen more. Other subindustries. including diversified chemicals, the largest subindustry group by par value, have seen spreads widen 20 bps in the past month.
Consumers of non-U.S. steel and aluminum have seen spread performance deteriorate in the wake of tariff announcements. The aerospace and defense industries are one of the most exposed to rising costs of materials with the tariffs. The chart below shows 1-month changes in spread to Treasuries for industry groups in the industrial sector. Transportation, aerospace defense and other manufacturing are the worst performing subgroups in spread terms over the past month. Still, with spreads wider by roughly 20 bps, these issuers aren’t seeing disastrous underperformance. That is in-line with the material sector. Other parts of the industrial sector remain in demand with manufacturing still humming overall.
There is a split within the aerospace and defense space. Spreads for United Technologies and Rockwell Collins are substantially underperforming Northrup Grumman, Raytheon, and other peers. The chart below shows the 1-month change in the spread by duration for issues in the aerospace and defense industry group by issues. United Technologies and Rockwell Collins have seen spreads widen 30-35 bps, 10+ bps more than similar duration peers. United Technologies is among those with the greatest exposure to the tariffs and CEO Greg Hayes has been a vocal opponent in the media.