Line graph compares credit spreads for investment grade, high yield, and emerging market (USD sovereigns) fixed income.
Y-axis: Option-adjusted spreads (%); X-axis: 2006-2022
High yield spreads generally exceed emerging market and investment grade spreads for this period, respectively. Spreads opened the period just above 3% for high yield, close to 2% for emerging markets, and slightly less than 1% for investment grade. Spreads for all three measures peaked in late 2008: above 18% for high yield, near 7.5% for emerging markets, and above 6% for investment grade. Spreads showed less dramatic peaks in late 2011 (8% high yield, above 4.5% emerging markets, and over 2% for investment grade). The same was true in early 2016 (above 7% high yield, nearly 5% emerging markets, and near 2% investment grade), and late 2018/early 2019 (above 5% high yield, above 4% emerging markets, and about 1.25% investment grade). Spreads spiked by Q1 2020 quarter end: high yield 8.8%, emerging markets about 5.8%, and investment grade about 2.70%. By 2020 year end yields had normalized somewhat: high yield about 3.6%, emerging markets near 3.2%, and investment grade about 1.0%. At the end of Q3 2022, emerging markets were at about 4.7%, high yield at about 5.5%, and investment grade at about 1.6%.
Sources: Bloomberg and Wells Fargo Investment Institute. Monthly data from January 1, 2006 to September 30, 2022. For illustrative purposes only. Option-adjusted spread is the difference in yield over equivalent-duration Treasuries. USD = U.S. dollar. Investment grade represented by Bloomberg U.S. Aggregate Bond Index. High yield represented by Bloomberg U.S. Corporate High Yield Bond Index. Emerging markets represented by J.P. Morgan Emerging Markets Bond Index Global (USD). Bloomberg U.S. Aggregate Bond Index is a broad-based index that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. Bloomberg U.S. Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. J.P. Morgan EMBI Global Index (USD) is a U.S.-dollar-denominated, investible, market-cap-weighted index representing a broad universe of emerging market sovereign and quasi-sovereign debt. Index returns do not represent investment performance or the results of actual trading. Index returns represent general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.
Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High-yield fixed-income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment-grade fixed-income securities. Foreign investing has additional risks including currency, transaction, volatility and political and regulatory uncertainty. These risks are heightened in emerging markets.
- Credit spreads were volatile in the third quarter, initially tightening on hopes of an early end to the Federal Reserve’s rate-hike cycle, then re-widening as the central bank pushed back. Emerging market sovereign credit spreads remain relatively contained, despite global recession fears, with performance hurt more by higher U.S. Treasury yields than wider spreads.
- We expect spreads of high-quality and low-quality bonds to widen further as the economic slowdown and a potential recession takes hold. At this time, we believe credit selectivity is key.