Credit spreads have widened significantly this month but they remain far from levels that would compel the U.S. Federal Reserve to step in, according to UBS.
“Current indicators suggest no immediate justification for intervention,” UBS strategists led by Matthew Mish wrote in a note dated April 13.
UBS uses the New York Fed’s Credit Market Distress Index to model how wide the premium to Treasuries that corporate debt would need to reach before the Fed jumped in. It estimates U.S. high-grade spreads would have to move about 200 basis points above Treasuries and junk bonds 720 basis points over to get the central bank to move.
That compares to 113 basis points and 419 basis points, respectively, as of Friday’s close.
While the Fed’s dual-mandate centers on maximizing employment and keeping inflation low, smooth functioning of credit and rates markets makes those goals possible. Past interventions have included lending to banks, asset purchases and establishing new facilities to support the market.
UBS recommends investors also look at measures of market liquidity and issuance volumes. It analyzes the history of Fed emergency interventions, mainly during the global financial and Covid crises.
“Spread widening tends to stabilize after emergency Fed cuts and spreads trade sideways,” wrote the strategists. “Quantitative and credit easing cause credit spreads to tighten, but direct purchases are more effective.”
UBS correctly predicted in 2020, during the height of the COVID-19 pandemic, that the Fed would move to support junk bond markets.
James Crombie, Bloomberg News
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