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Credit Insights

All Quiet on the Summer Front for Corporate Credit Markets

Volatility remained especially muted, the news flow was unusually uneventful, and there were no new issues of any significance priced.

The corporate bond market was extremely quiet last week. Volatility remained especially muted, the news flow was unusually uneventful, and there were no new issues of any significance priced. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) was unchanged at +116; the BofA Merrill Lynch High Yield Master Index widened 10 basis points to +386. The main impetus for the widening in the high-yield market was the decline in oil prices to approximately $43 per barrel, the lowest since November. As oil prices dropped, the credit spread of the energy sector widened 43 bps last week to +546. The average spread of the energy sector breached +500 last week, which was the first time credit spreads had risen above that level since November, when oil had last fallen below $45 per barrel. Elsewhere, volatility was nonexistent. Over the past four weeks, the average spread in the investment-grade market has varied by only 3 bps; in the high-yield market, the average spread has varied by only 20 bps.

The lack of volatility in the marketplace thus far this year has been partly due to lackluster economic growth. Real GDP in the United States expanded only 1.2% in the first quarter. While growth may accelerate in the second quarter, that acceleration may be short-lived. Robert Johnson, Morningstar Research Services LLC's director of economic research, provided a midyear update in a June 22 video, "Midyear Economic Forecast: Lower Inflation, Slow Growth." Johnson reiterated most of the projections he made at the beginning of the year, but he did lower his estimate for core inflation to 1.8%-2.0%. He continues to expect real GDP growth in 2017 to be 1.75%-2%, and he established a new forecast for economic growth in 2018 of 1.75%-2%. The prior week, Johnson said he thinks the Federal Reserve will not hike the federal funds rate this year; he believes it is more likely that the Fed will begin its program to reduce the size of its balance sheet as early as the September Federal Open Market Committee meeting. Johnson expects the plan will be to halt reinvesting the principal on maturing bonds to the tune of $10 billion a month. The Fed's goal will be to increase the portfolio roll-off to $50 billion per month, an annualized rate of $600 billion. Considering the balance sheet is well north of $4 trillion and the Fed would probably want to keep about $1 trillion of assets on its books, this would equate to a wind-down that occurs over multiple years.

As for the rest of the markets, volatility in fund flows has become nonexistent. Fund flows into high-yield open-end mutual funds and exchange-traded funds declined for the fourth consecutive week, turning into a slight outflow of $0.3 billion. Most of the outflows were among the open-end high-yield mutual funds, as the outflows from ETFs were close to zero. Year to date, high-yield fund flows remain negative: There has been a net redemption of $4.2 billion, consisting of a $4.9 billion withdrawal from open-end funds, which has only been partially offset by $0.7 billion of inflows into ETFs.

Morningstar Credit Ratings, LLC is a credit rating agency registered with the Securities and Exchange Commission as a nationally recognized statistical rating organization ("NRSRO"). Under its NRSRO registration, Morningstar Credit Ratings issues credit ratings on financial institutions (e.g., banks), corporate issuers, and asset-backed securities. While Morningstar Credit Ratings issues credit ratings on insurance companies, those ratings are not issued under its NRSRO registration. All Morningstar credit ratings and related analysis contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Morningstar credit ratings and related analysis should not be considered without an understanding and review of our methodologies, disclaimers, disclosures, and other important information found at https://ratingagency.morningstar.com.