Corporate Credit Spreads Trading in Tightest Decile of Historical Range
Highest weekly high-yield fund inflows over past year and fourth highest over past two years.
Although Treasury bond prices fell last week on reports that China's foreign-exchange officials recommended the country suspend its purchases of U.S. government bonds, risk assets continued to march higher across the board. The S&P 500 rose 1.6% and is already up 4.2% thus far this year, while oil surged to over $64 per barrel, its highest price since December 2014. In the corporate bond market, credit spreads tightened to levels not seen since before the global financial credit crisis as the sentiment for risk assets outweighed the sell-off in the Treasury bond market. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) tightened 4 basis points and ended the week at +92, its tightest credit spread level since June 2007. After tightening 22 basis points the prior week, the average spread of the BofA Merrill Lynch High Yield Master Index widened 1 basis point to end the week at +337. Considering that the high-yield market is trading at its tightest spread levels since mid-2014, this widening is indicative of a consolidating market as opposed to weakness. The high-yield index has only ever registered tighter credit spread levels before the global financial credit crisis.
Corporate credit markets have been buoyed by generally improving credit metrics, fewer debt-funded mergers and acquisitions or shareholder-enhancement programs, and the market's expectation that revisions to tax and regulatory policies will bolster corporate credit strength by invigorating economic growth and boosting earnings. In addition to supportive fundamentals at the company level, the economic outlook remains constructive.
At current levels, the investment-grade and high-yield indexes are trading much tighter than their long-term historical averages. Since 2000, the average spread of our investment-grade index is +165 and the average spread of the high-yield index is +604. 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 less than 9% of the time. Not only are credit spreads tighter now than in much of the recent past, but the average credit quality of the Morningstar Corporate Bond Index is lower than it was much of the time. Currently, the average credit quality of the Morningstar Corporate Bond Index is A-, whereas since 2000, the average credit quality has been A for much of the time.
In the high-yield market, the average spread of the BofA Merrill Lynch High Yield Master Index has registered below its current level about 9% of the time over the past 18 years. Most of the time that the corporate bond market indexes were tighter than the current credit spread was during the buildup to the 2008-09 credit crisis. During 2004-07, corporate credit spreads were pushed to historically tight levels as new structured investment vehicles were engineered to arbitrage the differentials in expected default risk; however, once the credit crisis emerged, investors found that many of these vehicles did not perform as advertised.
Treasury bond prices fell across the entire yield curve after reports that Chinese foreign-exchange officials recommended the country suspend its purchases of U.S. government bonds. This claim was later refuted, but by then, the damage was done. The yield on the 2-, 5-, 10-, and 30-year Treasury bonds rose 4, 6, 8, and 4 basis points, respectively, to 2.00%, 2.35, 2.55%, and 2.85%. At these levels, the yield on the 2-year Treasury bond is its highest since the midst of the global financial credit crisis and the yield on the 5-year Treasury bond is its highest since 2011.
After the Federal Open Market Committee raised the federal-funds rate at its December 2017 meeting, the market is pricing in an increased probability of another hike as soon as the March meeting. Currently, according to CME Group's FedWatch Tool, the market is pricing in a 74% probability that the Fed will raise the federal-funds rate at that meeting. In addition, the market is looking for additional rate increases over the remainder of the year, as the probability of the fed-funds rate being greater than 1.75% is 83% and greater than 2.00% is 47%. According to the projections released following the December meeting, the average projected federal-funds rate of the board members for the next three years is 2%, 2.70%, and 3% for years ended 2018, 2019, and 2020.
Highest Weekly High-Yield Fund Flows Over Past Year
and Fourth Highest Over Past Two Years
Fund flows in the high-yield asset class started the year by registering the highest amount of weekly inflows over the past year and the fourth-highest amount over the past two years. Fund flows consisted of $1.4 billion of inflows among open-end funds and $1.1 billion of new unit creation across high-yield exchange-traded funds, totaling $2.5 billion of inflows into the asset class for the week ended Jan. 10.
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.