By: Russ Kamp, Managing Director, Ryan ALM, Inc.
I suspect that most participants in the capital markets are aware of the implications of rising US inflation and the impact it has had on US interest rates so far in 2022. The US Federal Reserve has certainly raised awareness by twice elevating the Federal Funds Rate by a total of 75 basis points so far with a clear message that more is to come. Perhaps much more! What might be less apparent to the average investor is the impact of widening corporate credit spreads relative to Treasury securities.
My colleague and Ryan ALM’s Head Trader, Steven DeVito, has put together the following chart highlighting the major widening (yield change in the right two columns) that has occurred this year:
What we have witnessed so far is a widening of AA versus comparable Treasuries, but more important is the credit spread widening of BBBs versus AA. What was a 58 bps difference has ballooned to 90 bps as of last Friday. This action can have a profound impact on total return bond programs especially if there is a need for liquidity in the portfolio. On the other hand, credit spread widening has little to no impact on existing cash flow matching portfolios as the bonds are held to maturity.
On a positive note, wider spreads reduce the cost of defeasing pension liabilities when constructing new portfolios. As we’ve mentioned in previous blog posts, higher US interest rates and wider corporate credit spreads are creating an environment in which the cost to defease a pension liability stream is falling and in some cases, depending on the maturity of the program, quite significantly! We’ve just created a Liability Beta Portfolio™ for an SFA recipient that covers 30-years (to 2051) and generates a >40% savings on the cost of those future benefit payments. Who wouldn’t be pleased with that result?
Steve has promised to continue to monitor this widening situation. It will be interesting to see how high US interest rates go and just how wide the corporate spreads get. We may be able to provide benefit security for pennies on the $.