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Liquidity, not solvency concerns, driving fixed-income pricing

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Vishal Khanduja, CFADirector of Investment Grade Fixed-Income Portfolio Management and Trading, Calvert Research and Management

      Boston - The fixed income markets are experiencing signs of stress, but to date what we are seeing amounts to a massive liquidity issue, not yet evidence of a major credit-driven solvency problem. As of Friday, March 20, the spreads on investment-grade corporate debt over US Treasuries were about 300 basis points (bps). For single-A credits, that spread was at 250 bps or wider. In both cases, the spreads were the widest we have seen since the 2008 financial crisis.

      The liquidity vs. solvency question is best illustrated by the fact that the credit yield curve is currently inverted, and Verizon is a good example. Last week, the company's short-duration debt traded at 650 bps over the Treasury curve, yet its 30-year issue was 250 bps over the curve and 3x oversubscribed. Investors who are oversubscribing to a company's 30-year obligations aren't showing concerns over its solvency.

      At the same time, the front end of the curve is feeling the most pressure — that is what managers are selling to meet redemptions, or in anticipation of them. Some weaker, highly leverage credits may indeed be facing solvency questions, although that is not what is generating the curve inversion; it is the demand for cash. Happily, the Federal Reserve (Fed) has been very quick to address the liquidity issues through an expanding set of programs, but the full impact of the programs will take several weeks to emerge, so investors may have to endure some additional liquidity-driven volatility.

      For Eaton Vance's investment-grade strategies, we have focused on generating liquidity, and have raised cash levels to significantly higher than they were six months ago. But we are also trying to be a liquidity provider in certain defensive sectors and issues that we believe are best able to weather the changed economic landscape. This includes some tech companies, agency mortgage-backed securities and deeply discounted, short-duration single-A paper.

      Bottom line: For the time being, the need for liquidity is the main driver in our sector, and we are positioning our portfolios to take advantage of that. The Fed's new programs will go a long way toward improving liquidity, but they will need time to become fully effective.