Corporate Bond Markets Soften in Sympathy With Surging Volatility
After widening most of the week, credit spreads were unable to recoup much of their losses.
Volatility refused to subside last week as asset markets were whipped around by a barrage of headlines regarding the U.S.-China trade dispute. In the equity market, in four out of five days last week, the S&P 500 either fell or surged well over 1% per day, with the greatest swing occurring Wednesday, when stocks fell almost 3%. It was a similar story in the bond market as interest rates swung 5-10 basis points per day depending on investor sentiment as to whether the trade war was cooling off or heating up. Even the measurement of volatility was volatile. As measured by the CBOE's Volatility Index, the volatility of the S&P 500 traded between 17.8 and 23, depending on which way the market was headed at any one point. Corporate bond traders were whipsawed as they tried to keep up with the amount that credit spreads were either widening out or gapping in based on the swings across the equity markets and underlying interest rates.
Over the past 20 years, the movement in investment-grade credit spreads has had an 85% correlation with equity volatility as measured by the VIX; however, over the past six months, the correlation has dropped to only 40%. In an environment in which volatility stays elevated and the market reverts toward its historical correlation, the current gap between corporate credit spreads and volatility could condense.