Activity in Corporate Bond Market Winding Down
Action in the new issue market was virtually nonexistent and trading in the secondary market was muted.
Activity in the corporate bond market slowed to a crawl last week as action in the new issue market was virtually nonexistent and trading in the secondary market was muted. Portfolio managers have for the most part completed any year-end window dressing, and bond traders have wound down their positions. Volatility remained muted, and corporate credit spreads traded in a narrow range. Barring some exogenous shock to the capital markets, trading activity and new issue volume should be light for the remainder of the year. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) tightened 2 basis points to +98 while the BofA Merrill Lynch High Yield Master Index widened 1 basis point to end the week at +364.
As was fully priced in by the markets, the Federal Reserve increased short-term rates by raising the federal funds rate 25 basis points to 1.25%-1.50%. In its statement, the Fed noted that the labor markets have continued to strengthen and the economy has been growing at a steady rate. In addition, the Fed said, "Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters." However, as it may affect future monetary policy actions, the Fed said, "On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2%." The Fed released its updated projections, which include board members' forecasts for the federal funds rate. The average projected federal funds rate from the board members for the next three years is 2%, 2.70%, and 3% for years ended 2018, 2019, and 2020, respectively.
After a brief pause the prior week, the yield curve continued its flattening trend last week. The yield on the 2-year and 5-year Treasury bonds rose 5 basis points and 1 basis point, respectively, to 1.84% and 2.15%. At these levels, the yield on the 2-year Treasury bond is its highest since the global credit crisis and the yield on the 5-year Treasury bond is its highest since 2011. However, while short-term rates were rising, the yield on the 10-year and 30-year Treasury bonds fell 3 basis points and 8 basis points, respectively, to 2.35% and 2.69%.
The yield curve has been on a multiyear flattening trend since the Fed began to raise short-term rates in its pursuit to normalize monetary policy. Currently, as measured by the spread between the 2-year and 10-year bond, the yield curve is its flattest since before the global financial crisis.
This flattening trend may continue as it has been influenced by global central bank activities. The Fed has been raising short-term interest rates as it normalizes monetary policy. Based on the Fed's own projections and market expectations priced into the fed futures market, short-term rates are expected to rise even further next year. According to CME Group's FedWatch Tool, the market is pricing in a 68% probability that the Fed will raise short-term rates to over 1.75% by the end of 2018, and the average fed funds rate projected by the Fed is 2%. Although short-term rates have been rising, demand for long-term bonds has kept prices steady. The long end of the curve may be influenced by the ongoing quantitative easing programs of the European Central Bank and Bank of Japan. This demand will continue to be affected by global central bank activity as the ECB will not begin to taper its asset-purchase program until next year. Even then, the ECB will continue to continue to purchase EUR 30 billion per month until September 2018, which will infuse the eurozone with an additional EUR 270 billion of new money.
High-Yield Fund Flows Turn Negative Going Into Year-End
Fund flows in the high-yield asset class turned decidedly negative last week. High-yield open-end funds and exchange-traded funds registered a net outflow of $1.1 billion last week, consisting of $0.3 billion of withdrawals from open-end funds and $0.8 billion of net unit redemptions from ETFs. Year to date, the high-yield asset class has suffered total redemptions of $11.7 billion, consisting of $15.2 billion of redemptions in open-end mutual funds offset by $3.4 billion of new unit creation in ETFs.
In observance of the holidays, the next weekly publication of Credit Insights will be Jan. 8, 2018. Happy holidays to everyone!
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