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Credit Insights

Corporate Bond Market Holds Steady

New issue market beginning to awaken; moderate weekly outflows in high yield.

Irrespective of heightened global tensions, upcoming elections in Europe, and the lack of demonstrable political progress in effecting positive change in U.S. policies, volatility remained muted in the corporate bond market. The investment-grade market has been mostly in a holding pattern in which corporate credit spreads have been essentially flat over the past month; in the high-yield market, investor demand for yield has helped credit spreads grind slightly tighter.

The average corporate credit spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) was unchanged over the course of last week at +123. Over the past four weeks, the trading range of the average credit spread in the investment-grade index has fluctuated by only 2 basis points and since the end of last year has traded in a 10-basis-point range.

In the high-yield market, the Bank of America Merrill Lynch High Yield Master Index tightened slightly as credit spreads declined 6 basis points to end the week at +397. Over the past four weeks, there has been a little more volatility in the high-yield market as the index has traded in a 27-basis-point range and since the end of last year has traded in a 66-basis-point range. Much of the downside volatility occurred in mid-March when oil prices briefly dipped below $50 per barrel; however, high-yield corporate credit spreads quickly recovered when oil prices bounced higher. Since then, the markets' sensitivity to oil prices has subsided as oil has once again dipped below $50 per barrel. Rising production led to a 3.5% decline in oil prices last week to $49.61 per barrel, but the average spread in the energy sector only widened 4 basis points to +443, near the middle of its trading range since the end of last year.

In addition to the apparent discounting of potential international risks, the domestic economic situation has failed to spur volatility. According to the GDPNow forecast released by Federal Reserve Bank of Atlanta, first-quarter GDP growth appears to have mostly stagnated. First-quarter economic growth is projected to be only 0.5%. This represents a significant reduction from the 2.5% pace the Atlanta Fed had expected as recently as Feb. 27. In our Second-Quarter 2017 Corporate Credit Market Insights published March 28, we noted that Robert Johnson, Morningstar, Inc.'s director of economic analysis, was expecting that GDP growth in the first quarter would only be about 1.0%. His estimate was well below the average consensus expectations of Wall Street economists.

Although the first quarter appears dour, Johnson expects economic growth will rebound toward a more normalized level in the second quarter. He forecasts GDP growth to increase to 2.1% for the second quarter and range between 1.75% and 2.0% for the full year. He expects that at the end of this year, the yield on the 10-year U.S. Treasury will be 3.00%-3.50% and the run rate of inflation will be 2.00% on a fourth-quarter over fourth-quarter basis.

New Issue Market Beginning to Awaken; Moderate Outflows in High Yield
New issue volume in the corporate bond market remained low last week as earnings season continues, but it has been picking up as companies that report early during earnings season have tapped the public capital markets. For example, several of the large global banks that we rate were active in the markets. As other companies announce quarterly earnings, we expect the pace of new issues will pick up steam as companies look to either refinance near-term maturing debt or take advantage of low yields and relatively tight corporate credit spreads.

While there was a moderate amount of outflows in the high-yield sector over past two weeks, investors in fixed income generally stayed their course. Among the high-yield mutual funds and exchange-traded funds, $0.5 billion of assets were withdrawn last week and $1.3 billion were redeemed the prior week.

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