U.S. credit yields drop to multi-month lows amid surge in risk appetite: SocGen

[Bond yield with dollar banknotes. Business and financial management.]
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U.S. credit markets led a broad rally in fixed income last week, with both investment-grade and high-yield bond yields falling to their lowest levels in over two months. The moves signaled strong investor appetite for risk, according to strategists at financial-services firm Société Générale.

The yield on the USD IG index dropped 12 basis points to 5.65%, while the USD HY index saw an even steeper decline: down 19 basis points to 7.51%. These moves came as credit spreads tightened and sovereign bond yields improved across major markets.

"The credit markets had an outstanding performance in the past five weeks and recovered in May the ground lost in April," Juan Esteban Valencia, European credit strategist at SocGen, said in a May 30 report to clients, adding that momentum was driven by both technical and fundamental support.

“After the sharp volatility increase in late March and early April pushed risk aversion higher, the markets not only stabilized but have come back roaring,” he said. “And, in our view, there is more to come.”

EURO AREA ALSO RALLIES

The rally extended across the Atlantic as well. Euro-denominated credit markets regained ground lost in April, despite absorbing nearly €150 billion ($170 billion) in new issuance since late April. The euro IG index yield fell to 3.31%, a monthly low, while euro HY yields declined 13 basis points to 5.58%, their lowest since March.

Valencia said investor demand has been especially strong in higher-beta segments such as subordinated financials, corporate hybrids and autos.

While issuance has averaged €30 billion a week recently, SocGen expects supply to moderate. Still, the bank anticipates continued strength in secondary markets, with financials likely to outperform non-financials and high-beta credit leading excess returns in both U.S. and euro markets.

RISKS STILL LURK

Despite the bullish momentum, Valencia cautioned that trade policy remains a key risk. A brief but sharp announcement last week of a 50% tariff on European exports to the U.S., though quickly reversed, highlighted the market's vulnerability to sudden political developments.

There are also concerns around slowing economic growth. Although the U.S. posted a -0.2% GDP contraction in the first quarter, SocGen said mild growth in the 0.3% to 0.5% range is still supportive of IG credit. High-yield, however, may struggle if spreads compress further.

The greatest concern remains a deep or prolonged recession, which could send spreads back to levels last seen in the wake of Credit Suisse’s collapse. For now, though, SocGen sees that outcome as a tail risk rather than a base case.

“We don’t expect appetite for the asset class to slow much, if at all, and we therefore see the secondary market gaining further ground, with financials outperforming non-financials and the higher-beta sectors still leading the way,” Valencia said, “and this would mean higher excess returns across the board, in both the euro and USD markets.”

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