May Be Cold Outside, but Feels Like Summer Doldrums in Corporate Bond Market

Many areas of the country are still experiencing unusually cold weather for this time of year; for example, it's in the 30s this morning in Chicago. However, activity in the corporate bond market last week felt more like being in the summer doldrums. Volatility dwindled over the course of the week, trading action felt light, and new issue activity was muted. Asset markets were generally unchanged to slightly weaker, with the resulting volatility declining to the bottom of its range thus far this year. The average spread of the Morningstar Corporate Bond Index widened 3 basis points to +112, and the average spread of the BofA Merrill Lynch High Yield Master Index widened 11 basis points to +344 basis points. The S&P 500 ended the week essentially where it began, and oil dropped a few cents per barrel.

Along the shorter end of the yield curve, the yield on the 2-year Treasury bond rose 2 basis points to 2.48%, and the yield on the 5-year Treasury bond was unchanged at 2.80%. The yield on the 10-year Treasury briefly traded above the 3% psychological threshold, but the higher yield quickly brought out buyers and the higher price brought the yield back down to 2.96% by the end of the week. Investors also found value in the longest point on the curve, and the resulting demand pushed the interest rate on the 30-year bond down 3 basis points to 3.12%.

Although earnings season often leads to market volatility, this quarter's reports have generally been uneventful from a credit point of view. While there have been several hits and misses, none of these have affected our overall view of the trend for corporate credit quality. The technical underpinnings of the corporate bond markets held steady as supply and demand in the investment-grade bond market remained balanced. Similar to the prior week, demand from international investors remained muted; the real underlying demand in the marketplace came from domestic buyers. There has been some renewed demand for shorter-duration paper as the higher all-in yield on short-term bonds has attracted investors, but the demand has been from a different investor base than last year. In addition to the re-emergence of buyers in the short end, one corporate bond trader said some institutional investors have been looking to trade up in quality by swapping out of lower-rated issuers into higher-rated ones.

Over the past few weeks, headline and core CPI numbers have run closer to the Fed's inflation goal, and investors are pricing in several more hikes to the federal-funds rate this year. According to the CME FedWatch Tool, the market-derived probability that the fed-funds rate will end the year at 200 basis points or higher is 90%; the probability that the fed-funds rate will end the year at 225 basis points or higher is 47%. There is only a 7% probability that the Federal Reserve will hike the fed-funds rate by 25 basis points from the current 1.50%-1.75% following the Federal Open Market Committee meeting May 1-2. However, the market is pricing in a rate hike with near certainty following the meeting June 12-13, when the Fed releases its next Summary of Economic Projections and Chairman Jerome Powell conducts a press conference. The market-implied probability of a 25-basis-point hike in June is 88% and the probability of a 50-basis-point hike is 12%.

Surge in High-Yield Inflows Short-Lived
A week ago, we noted that the $2.5 billion surge of weekly inflows into high-yield open-end mutual funds and exchange-traded funds through April 18 might be short-lived. We pointed to a $531 million net unit redemption across the high-yield exchange-traded funds on April 19, the day after our weekly high-yield fund flows were calculated. For the week ended April 25, total net outflows in the high-yield sector were $2.3 billion: $0.3 billion of withdrawals from high-yield open-end funds and $2.0 billion of net unit redemptions across ETFs. Year to date through April 25, there has been $12.6 billion of outflows across the high-yield sector: $7.1 billion of outflows from open-end high-yield mutual funds and $5.5 billion of net unit redemptions from high-yield 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.