After Shallow Sell-Off, Corporate Credit Spreads Stabilize
Credit spreads in the corporate bond market stabilized last week after a brief sell-off the prior week pushed spreads higher. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) tightened 2 basis points to +113, and the average credit spread of the BankAmerica Merrill Lynch High Yield Master Index tightened 2 basis points to +398.
While activity in the corporate bond markets typically experiences a seasonal slowdown in August, as many investors and investment bankers are on vacation, the new-issue market remained active last week. As evidence, even though issuers typically shy away from the new-issue market in August, Amazon.com (AMZN) (A, stable) issued a $16 billion, seven-part transaction with maturities ranging from three to 40 years. Proceeds from the new senior notes will be used as part of its planned financing to complete its acquisition of Whole Foods (WFM). Amazon’s A rating reflects ongoing improvement in its competitive position as evidenced by a multiyear expansion in EBITDA margins and return on investment, along with the maintenance of moderate leverage and excellent liquidity. While MCR believes the transaction will have a negligible impact on Amazon’s credit risk, the acquisition marks an important milestone in Amazon’s grocery business. While Amazon’s current grocery offering is largely limited to online shopping, it is testing a fully automated grocery store near its headquarters. MCR anticipates that Whole Foods’ 460 stores in the United States, Canada, and the United Kingdom will be integrated with AmazonFresh, providing online delivery as well as a location for customer pickup.
Earlier this month, British American Tobacco (BATS) (BBB, stable) decided to issue $17.25 billion worth of bonds to fund its acquisition of Reynolds Tobacco. This transaction is the second-largest corporate bond deal issued this year, surpassed only by AT&T’s (T) (BBB/UR-) $22.5 billion transaction, which itself was the third-largest corporate bond deal in history. The proceeds from the AT&T transaction will be used as the final installment for the permanent financing of its pending acquisition of Time Warner (TWX) (rating: BBB+/UR-). In addition, McCormick & Co Inc (MKC) (A+/UR-) had issued $2.5 billion of new bonds two weeks ago to finance its acquisition of Reckitt Benckiser's food division.
With the largest of the transactions expected to fund mergers and acquisitions out of the way, the remainder of August should be relatively quiet. Second-quarter earnings reports have wound down and, except for some additional pressure in the retail sector, have been generally in line with the usual amount of hits and misses. Thus far, our corporate credit analyst team has not discerned any significant change to their sector outlooks. From a macroeconomic perspective, economic metrics remain strong, and the GDPNow forecast published by the Federal Reserve Bank of Atlanta for third-quarter GDP growth has risen to 3.8%. However, the Federal Reserve’s annual economic policy symposium held in Jackson Hole, Wyoming, is this week. The conference will be closely watched, as Federal Reserve Chair Janet Yellen is scheduled to speak on Aug. 25 at 10 a.m. Eastern Standard Time. As part of her speech, which is expected to address financial stability, she may also provide additional information on the Fed’s view toward its balance sheet normalization plans. In addition, European Central Bank President Mario Draghi is scheduled to attend the symposium. Any comments from Draghi will be closely scrutinized in case he alludes to any changes to the timing and composition of the ECB’s quantitative easing program.
While the Fed did not make any changes to its monetary policy at its July meeting, its recently released minutes revealed that it remains concerned about a potential resurgence in inflation and that it has not changed its expectation for the economy to expand at a consistent rate. Assuming there aren’t any significant negative catalysts before the next Fed meeting, the market is expecting that the Fed will begin its balance sheet normalization program in September. To start winding down the size of its balance sheet, the Fed will begin to gradually reduce the amount of interest income and principal repayments it reinvests by $10 billion per month. Once the reduction program begins, the Fed will then increase the amount of reduction by $10 billion per month until it reaches a cap of $50 billion per month. The Fed will then let $50 billion per month roll off its balance sheet until it decides that it is no longer holding more securities than necessary to implement its monetary policy.
Through the week ended Wednesday, Aug. 16, investors pulled $2.3 billion of assets out of the high-yield market. Among the open-end funds, investors withdrew $1.0 billion of funds, and across the high-yield exchange-traded funds, there was $1.3 billion of net units redeemed.
- source: Morningstar Analysts
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David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.