Bonds Get Another Boost
The ECB's QE program and soft economic data have driven fixed-income returns, while miserly yields on sovereign debt make U.S. corporates more attractive to global investors.
Declining interest rates across the world have driven strong returns among fixed-income securities in the first quarter. The ECB began its long-awaited QE program in early March, and this has helped to push bond prices up so high that yields have not only reached new all-time lows in the eurozone but, in some cases, have driven interest rates into negative territory. Considering that interest rates on sovereign bonds in developed markets are near their historically lowest levels, we think that corporate bonds should outperform on a relative basis.
In the first quarter of 2015, fixed-income returns were predominately driven by declining interest rates. On the shorter end of the curve, interest rates tightened as commentary from the [Federal Open Market Committee's] statement along with weakening economic indicators are prompting investors to bet that the Fed will keep interest rates lower for longer.
On the longer end of the curve, interest rates were driven lower by a combination of softening economic conditions in the U.S. as well as heightened demand from global investors. Compared with the minuscule interest rates in Europe and Japan, foreign investors have been attracted to U.S. denominated fixed-income securities, which allow them to pick up the higher yields that U.S. corporate bonds offer as well as invest in the safety of the strengthening dollar. Highlighting this differential in yields, the spread between the 10-year U.S. Treasury and 10-year German Bund has risen to the widest spread that Treasuries have ever had over Bunds.
The Morningstar Core Bond Index, which is our broadest measure of the fixed-income universe, rose 1.63% in the first quarter; whereas, due to its longer duration, the Morningstar Corporate Bond Index rose 2.25% in the first quarter. Corporate credit spreads in the investment-grade sector were almost unchanged for the quarter, only tightening 2 basis points since the end of last year and currently stand at 138 basis points over Treasuries. In the high-yield sector, the average spread of the BofA Merrill Lynch High Yield Index tightened 22 basis points to 482.
In the near term, we expect corporate bonds will continue to outperform the Treasury bond market as credit spreads will likely tighten. As the ECB buys sovereign and structured-finance bonds, those proceeds will most likely be re-invested in the corporate-bond market. This demand should drive corporate credit spreads across both European as well as U.S. markets tighter as demand outstrips new-issue supply.