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Credit Insights

Corporate Credit Bond Spreads Continue to Lag Equity Rally

GDP grows 3.5%, but is likely to moderate in the fourth quarter.

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While the stock market bounded higher last week, credit spreads in the corporate bond market languished by comparison and continued to lag the equity rally. The average spread of the Morningstar Corporate Bond Index tightened less than 1 basis point and ended the week at +124. In the high-yield sector, the Bank of America Merrill Lynch High Yield Master II Index tightened a measly 8 basis points to +430. While the S&P 500 rose 2.7% and is back to hitting new all-time highs, both investment-grade and high-yield spread levels are still well wide of their tights earlier this year. The tightest level our investment-grade bond index reached earlier this year was +101 on June 24, and the tightest the high-yield index reached was +335 on June 23. Considering that the high-yield market is typically much more correlated with movements in the equity market and $1.7 billion of funds flowed into high-yield mutual funds and exchange-traded funds last week, it was surprising that high yield did not perform better.

As expected, the Federal Open Market Committee decided to finish winding down its asset-purchase program and halted any further purchases. What was unexpected was that the FOMC took on a slightly more hawkish tone (meaning the committee members may be more inclined to begin tightening monetary conditions than loosen them) than in prior statements. For example, the FOMC changed the language in its statement to note that unemployment has improved substantially since the beginning of its current asset-purchase program and underutilization of labor resources is gradually diminishing. This is a change from last month's statement, in which it noted that there remained significant underutilization of labor resources. The FOMC did keep its language that the federal funds rate would remain near zero for a considerable time following the end of its asset-purchase program. Of particular note this month, the only dissenting vote was from Narayana Kocherlakota, who is generally regarded to be one of the biggest doves on the committee. Doves are generally known for preferring looser monetary conditions such as low interest rates. He suggested that the Federal Reserve should commit to keeping the federal funds rate near zero until the outlook for inflation returns to the Fed's 2% target and should continue the asset-purchase program. This is a turnaround from last month, when it was Richard Fisher and Charles Plosser, two monetary hawks, who dissented.

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