Corporate spreads opportunities - Spikes and reversals

In spite of positive, albeit modest growth and firm equity prices, corporate spreads for lower quality corporates have started to move higher. BBB corporate spreads have come off lows for the year and are still below average. BB corporate spreads are also off their lows which have been tested twice before. A careful look at the quality spread of BB - BBB shows strong widening. We have seen this spread performance before with this behavior being the potential fifth quality spike over the last year. The charts show the BBB, BB, and the quality differential against three different  moving averages.

Corporate spreads as measured by the BAML indices represent the weighted average of yield above Treasuries across a rating. There will be dispersion across individual names and sectors. The spread includes the credit risk premium, the expected default risk, downgrade risk, and a liquidity premium. There will be a link with equity risks associated with the fundamentals of corporate finance. There will be a link with volatility and the flow of funds. These spreads will increase if there is an equity decline, a slowdown in economic growth, and a spike in volatility. While there are growing risks with the growth of debt and leverage, a true sustained spike in spreads may be premature. However, we have seen a number of quality spikes (BB-BBB) this year that have then reversed. These are technical opportunities for active traders.