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Credit Insights

Credit Spreads Brace for Economic Mediocrity

Weaker-than-expected economic indicators in June led to widening corporate bond spreads, reflecting a dislocation in the markets.

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Corporate bond spreads widened out this week as a result of weaker-than-expected economic indicators and in sympathy with the decline in the equity markets. Credit spreads widened about 3 basis points across the board as investors fled risk assets and piled into Treasuries. There appears to be a dislocation in the markets, as the last time the 10-year Treasury was inside 3% was April 2009. At that time, credit spreads were 60 basis points wider and the S&P 500 was around 850. We believe the credit market is beginning to price in assumptions for slower economic growth in the second half and a resulting deceleration from the rapidly improving credit metrics we had experienced during the past year.

Once again, U.S. corporate credit spreads outperformed their European counterparts. Sovereign concerns, a weak euro, and austerity measures will probably depress European gross domestic product growth, thus limiting credit improvement. Although credit counterparty risk in the United States continues to recede, as indicated by the TED spread, which declined 5 basis points to 36, and a declining LIBOR rate, there are continuing signs that liquidity among European financials is deteriorating.

David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.