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Credit Insights

Corporate Credit Spreads Widen; High Yield Outperforming Investment Grade Thus Far This Year

Economic contraction in first quarter should prove to be an anomaly.

Corporate credit spreads weakened last week as economic news was generally disappointing and the equity markets sold off. In the investment-grade space, the average spread of the Morningstar Corporate Bond Index widened 6 basis points to +141. In the high-yield space, the average spread of the Bank of America Merrill Lynch High Yield Master II Index widened 5 basis points to +452. Since the end of last year, investment-grade bond spreads have given back all of their prior gains and are 1 basis point wider. Credit spreads in high yield are still 52 basis points tighter than the end of last year.

In our first-quarter outlook published late last year, we made our case on why we expected high yield to outperform investment grade this year. Year to date, the high-yield index has returned 4.06%, whereas the investment-grade index has only returned 0.99%. Much of the outperformance has been driven by the recovery in the energy sector. In our Jan. 12 publication, we noted that per-barrel oil prices had appeared to bottom out in the mid-$40s. Since then, oil has risen to over $60 and ended last week at $60.30. As oil prices rebounded, so did bonds in the energy sector. In our investment-grade index, the average credit spread in the energy sector tightened 45 basis points to +189, and in the high-yield market, credit spreads in the energy sector have tightened 113 basis points to +643. After increasing steadily over the past few months, it appears that the rise in oil prices is slowing. As such, the relative outperformance of the energy sector as compared with the rest of the index will diminish, thus potentially limiting further gains over the next few months.