Corporate Bond Credit Spreads Return to Multiyear Lows
After peaking in February 2016 when oil prices bottomed out, corporate credit spreads have been on a nearly uninterrupted tightening trend.
After peaking in February 2016 when oil prices bottomed out, corporate credit spreads have been on a nearly uninterrupted tightening trend. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) tightened 3 basis points to +101 last week. At this level, the investment-grade index is 46 basis points tighter than the median and 65 basis points tighter than the average spread since January 2000. As an indication of how tight corporate credit spreads have become compared with their historical averages, since the beginning of 2000, the average spread of the Morningstar Corporate Bond Index has registered below the current level only 20% of the time. In the high-yield market, the average credit spread of the BofA Merrill Lynch High Yield Master Index tightened 4 basis points to +352. Over the past few years, credit spreads were the tightest in mid-2014, when they reached +101 in the investment-grade market and +335 in the high-yield market. Before then, credit spreads have only ever been tighter in the runup to the 2008-09 credit crisis.
The tightest level the Morningstar Corporate Bond Index has registered is 21 basis points tighter at +80 basis points in February 2007. While this data point might suggest there is still more room for the index to run, the average rating of the index is lower now than it was back then. The average rating of the index is currently A-, whereas in February 2007, it was single A. Considering that the spread differential in the market between A and A- bonds is currently 11 basis points, on a rating-adjusted basis it appears that there is much less room for credit spreads to tighten before they return to their historically tightest levels. With spreads grinding tighter and tighter, investors have been stretching further into lower-rated fixed-income securities to reach for yield. As a result, the spread between corporate bonds with different ratings has been compressing. For example, the spread differential between the average single A and BBB bond in the Morningstar Corporate Bond Index has declined to +44 basis points from +66 basis points a year ago; over a longer period, the average spread differential between these rating categories is +70 basis points.
Investor demand for corporate bonds has been supported by solid fundamentals underlying corporate credit risk. Healthy earnings have led to improving credit metrics, and the number of actions that companies have undertaken to return capital to shareholders at the expense of bondholders has remained low. However, the new issue market was relatively lackluster last week, with not enough new issues to satiate investor demand. Instead, investors turned to the secondary market to put cash to work, and credit spreads tightened as investors had to bid at ever tighter levels in order to source bonds.
High-Yield Fund Flows
For the week ended Oct. 4, high-yield exchange-traded funds and open-end mutual funds experienced a net inflow of $1.5 billion. The inflows comprised $0.9 billion of inflows into high-yield ETFs and $0.6 billion into open-end mutual funds.
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.