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Keep Your Fixed-Income Focus On Credit Spreads Compared To Yield Curve Inversion

Yield curve inversion or credit spreads? Which is more worrisome to me? In the current environment, I’ll vote for credit spreads. A yield curve inversion is important to follow, but is not necessarily a predictor of stock market declines. 

For C&N, the credit spread tightening is more worrisome. Why? As we’ve been stating for most of this year, the fixed-income market is as elevated - if not more than - the equity market. The tightening of credit spreads has reduced the risk/return scenarios within fixed-income dramatically. In essence, if we are not being paid the appropriate yield for taking on credit risk, then why would we want to own anything but higher quality bonds? Including Treasuries?

The statistics on credit spreads is revealing. The thirst for yield in the fixed-income markets over the past two years have driven spreads to very tight levels. If things go bad in the market (stock or bond), higher quality bonds may shine.

Our conclusion: stay diversified within fixed-income and focus on credit spreads. Your high-quality bonds may not produce the yield you desire, but it’s likely they will perform better when things get rocky, which may or may not happen due to a yield curve inversion.

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