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Credit Insights

Largely Uneventful Week in Corporate Bond Market

U.S. employment report just right: not too hot, not too cold.

Last week was largely uneventful in the corporate bond market. No major surprises came out of earnings reports, and while the amount of new issues brought to market was full, it was not excessively large. Credit spreads in the corporate bond market ended the week unchanged from the prior week. The average spread of the Morningstar Corporate Bond Index, our proxy for the investment-grade market, ended Friday at +132, and in the high-yield market, the Bank of America Merrill Lynch High Yield Index ended the week at +453. Fund flows for high-yield open-end mutual funds and exchange-traded funds showed a $2 billion net outflow for the week; however, our data is captured on a weekly basis through Wednesday night. Considering that U.S. equity markets spiked higher after the employment report as the risk-on mentality returned to the markets, we would not be surprised to see the outflow reverse this week.

U.S. Employment Report Just Right: Not Too Hot, Not Too Cold
Nonfarm payrolls rose by 223,000 jobs in April and the unemployment rate dropped to 5.4%. Both of these measures were in line with analyst expectations. The level of job growth helped to offset concerns that the economy was slipping backward as employment growth reported in March was only 126,000 jobs, which was subsequently reduced to 85,000. Hourly wage growth rose only 0.1% in April (which when annualized is about 1.2%) compared with March; however, on a year-over-year basis, wage growth rose 2.2%, which should help to maintain consumer confidence.

The stock market spiked higher and bond prices rose modestly. The increase in payrolls was just hot enough to erase fears that the U.S. economy was slipping into recession, but remained cool enough to likely pressure the Fed to hold off on raising interest rates until September or possibly even December.

According to Robert Johnson, Morningstar's director of economic analysis, the weak employment growth since the beginning of the year has averaged only 194,000. As such, he has reduced his forecast for job growth for the year to average 220,000-240,000 jobs from his earlier forecast of 250,000. To hit his new forecast, employment will need to average about 248,000 per month for the remainder of the year. Johnson attributed the lower job growth to softness in the energy and manufacturing sectors, which are only partially offset by increases in the housing and health-care sectors. For greater detail on the employment situation and Johnson's take on wage growth, please see his weekly report.

China Adds Fuel to the Fire
Over the weekend, the Chinese central bank lowered interest rates. It cut the one-year benchmark lending rate by 25 basis points to 5.1% and cut the deposit rate by 25 basis points to 2.25%. This is the third rate cut since November and comes on the heels of the central bank's cut to the reserve requirement ratio a few weeks ago. While the Chinese economy had reportedly grown at a 7% rate in the first quarter, that pace of growth was a sequential decrease from the 7.3% rate recorded in the third and fourth quarters of 2014 and a decline from the 7.5% rate in the second quarter and 7.4% in the first quarter. Recent economic indicators show that the Chinese economy is continuing to decelerate. For example, Markit's HSBC China Composite Output Index dropped to its lowest level in the past three months with a reading of 51.3, a sequential decline from 51.8 last month. A reading of 50 is the demarcation between economic expansion and contraction. The lower composite reading was mainly based on stagnation in the manufacturing sector as the Manufacturing PMI has fallen to 48.9; however, this was partially offset by a rise in the Services PMI, which rose to 52.9.

We previously highlighted that the parabolic rise in the Shanghai and Hang Sang Indexes have reportedly been driven by a combination of expectations for easing monetary conditions in China and the preference to invest in stocks as the property markets remain in the doldrums. At the end of March, China's central bank governor publicly remarked that China's growth rate and inflation rates are declining too much and that the central bank has the capacity to ease additional policies and interest rates even further. In addition, speculation is building that China is close to launching its own quantitative easing program in order to further loosen monetary policy.