The latest power in US financial knowledge has been excellent news, and means much less threat of imminent recession. But it surely isn’t making high-quality company bonds any extra engaging — particularly relative to money.

It isn’t clear why, precisely, company bonds are buying and selling at such a slender unfold over Treasuries are so slender. Brief-maturity payments, which don’t have any threat of default and are primarily money (so long as the US doesn’t fumble on its debt restrict and nuke international markets), yield greater than 4.5 per cent. The broad investment-grade bond market pays 5.2 per cent.

One might argue that regular financial progress ought to assist firm fundamentals. However the sort of financial power issues for credit score, as Barclays argues in a Friday word.

Going by PMI knowledge, the US service sector is rising whereas the US manufacturing sector is just not. The truth is, the hole between the 2 metrics has not often been this broad, particularly at a time when financial institution credit score is contracting, in line with the Fed’s survey of senior lending officers.

And in these occasions — when companies are rising, manufacturing is shrinking, and banks are lending much less — company bonds normally commerce at wider spreads to Treasuries. From Barclays:

Spreads look like buying and selling too tight in relation to present PMIs and US banks lending circumstances. When banks are tightening lending circumstances materially and manufacturing PMI is contracting, spreads are normally a lot wider, even when companies PMI is increasing. The late-2000 interval appears to be the most effective historic comparability to present circumstances. Funding grade traded at round 180bp and excessive yield traded round 700bp then (Determine 6).

To match, investment-grade bonds are buying and selling at a 122-basis-point unfold, and high-yield bonds are buying and selling at a 417-basis-point unfold.

The manufacturing sector issues extra today, too. Barclays finds that producers make up a higher share of the investment-grade bond index than it did 20 years in the past:

In all, this doesn’t bode nicely for company bonds.

Goldman Sachs is changing into marginally extra bearish on high-quality company bonds as nicely, although for them largely it’s a matter of the comparability to money. With our emphasis:

Even when long-dated Treasury yields keep anchored round present ranges, we expect spreads are more and more dealing with binding valuation constraint. That is particularly the case for the excessive finish of the IG high quality spectrum which has to deal with the re-emergence of money as a competing and rewarding various. As proven in Exhibit 2, the yield pick-up supplied by A-rated bonds over the 3-month Treasury payments (a proxy for money) has just about vanished. Put one other approach, till the yield curve re-steepens, credit score and period threat taking incentives will doubtless reset decrease.

Due to this, the financial institution’s credit score strategists downgrade higher-quality bonds (rated A-, A and A+) relative to the bottom three tiers of IG:

Downgrading A-rated bonds to a impartial allocation vs. BBBs (from chubby beforehand). In early September, we beneficial upgrading A-rated bonds to an chubby allocation vs. their BBB-rated friends. Two key substances underpinned this view. The primary was relative valuations, as mirrored within the skinny extra unfold premium offered by BBB-rated bonds relative to the post-global monetary disaster interval. The second was the bigger publicity of the A-rated bucket to Banks (which account for 44% of the index), a sector that we had been recommending an chubby allocation on. As Exhibit 6 reveals, this view has performed out, with A-rated spreads materially outperforming their beta to their BBB-rated friends all through the rally. The place to from right here? We advocate shifting again to a impartial allocation.

What in regards to the bonds within the highest two scores tiers, AAA and AA? Nicely, it isn’t clear why we (or Goldman’s shoppers) ought to care. Mixed, they make up lower than one-tenth of the index, in line with ICE knowledge.