Given the magnitude of credit spread widening during the 2nd quarter, it should not be too surprising that the investment grade credit market recovered during 3Q 2018. However, given ongoing concerns about rising interest rates, trade tensions, Italian sovereign risk, and the growth of the BBB-rated segment -- the magnitude of the recovery was somewhat unexpected. The option-adjusted spread on the Bloomberg Barclays US Corporate Index tightened 17 basis points (bps) to 106 over the three month period ending September 30, 2018. This compares to 93 bps at the beginning of the year, and 101 bps at the end of 3Q 2017. In the U.S. Treasury market, the benchmark 10-year yield increased from 2.85% on June 30, 2018 to 3.057% on September 30, 2018– after having traded as high as 3.101% and as low as 2.82% during the quarter.
Most of the spread retracement occurred during July, as strong earnings combined with solid economic data to foster a "risk on" tone. Interest rates moved higher, leading to increased demand as all-in-yields (UST rate plus credit spread) become more compelling. This positive technical was helped by a muted new issue calendar. Not surprisingly, given the rally, the best performing sectors tended to be those with higher spread beta and lower credit ratings. The July snap back was the strongest monthly excess return performance for the Bloomberg Barclays U.S. Corporate Index since April 2016, though total returns were hurt by the selloff in Treasuries.