Fading attractions…Losing the love for credit as spreads remain tight

In a series of dedicated blog posts, we’ll examine macro and market indicators worth paying close attention to as investors navigate the world of credit. First up: valuations

When it comes to interest rates, you can’t get more different than what’s happening in the U.S. and Canada. Stateside, we anticipate up to three more rate increases this year as the already healthy U.S. economy gets a procyclical boost with U.S. tax reform and fiscal stimulus. In contrast, since last fall, economic activity in Canada has decelerated, leading to a more cautious normalization path from the Bank of Canada.

What does this mean for investors? For starters, holding some Canadian duration makes sense because we don’t see Canadian rates coming under as much pressure as in the U.S. Strategically, credit exposure can provide attractive potential income, though at this point in the cycle some caution is warranted. While we still believe the global expansion has room to run, we’re also actively monitoring early signs of potential overheating in the late cycle environment.

When it comes to valuations, U.S. and emerging market credit spreads reached post-crisis tights in late 2017, reflecting low default risks against a backdrop of solid global growth. Since then, we’ve seen a modest widening in spreads as investor sentiment shifted and volatility picked up amidst U.S. trade policy uncertainty and building geopolitical tensions.

Rising volatility and rising interest rates are typically associated with higher risk premia. Despite the recent moves, spreads remain tight compared to historical levels. In fact, credit spreads in many markets are trading at the lowest levels as a percentage of their overall yield in a decade (see chart below). With the potential for additional volatility and rate rises on the horizon, credit assets are less attractive at these levels. That’s why we recently reduced exposure to credit risk in our iShares strategic income portfolios. Looking forward, if spread levels widen again, we’ll look to adjust accordingly. For more on our strategic income portfolios, check out the fixed income section on our site.

iSH Blog graph Apr18.1

iShares® ETFs are managed by BlackRock Asset Management Canada Limited. Commissions, trailing commissions, management fees and expenses all may be associated with investing in iShares ETFs. Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

© 2018 BlackRock Asset Management Canada Limited. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission.