Credit Spreads Largely Unchanged Last Week
But falling oil prices have pressured corporates over the past month.
Corporate bond markets rallied for much of last week, but credit spreads gave back some of the gains in sympathy with the pullback in the equity markets Friday. While the S&P 500 registered a gain of 2.13% for the week even after accounting for the swoon Friday, corporate credit spreads were largely unchanged. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade market) tightened 2 basis points to end the week at +120. The BofA Merrill Lynch High Yield Master Index was essentially unchanged, tightening 1 basis point to end the week at +371.
While there was little movement across the broad corporate bond market indexes last week, they have been under pressure over the past month. The energy component of the indexes has been weakening as oil prices have fallen 22% from their recent highs at the beginning of October to below $60 per barrel last Friday. Oil prices peaked Oct. 3 at $76.40 and have fallen to below $60 as of Friday, while the average spread of the Morningstar Corporate Bond Index has widened 11 basis points to +120 from +109. Over this period, the energy component of the index has widened 22 basis points. The high-yield index has widened 55 basis points to +371 from +316 as the average spread of the energy component of the index has widened 98 basis points to +455 from +357.
In 2014 and 2015, the free-fall in oil prices had an outsize impact on the high-yield market as the energy sector represents 16% of the overall index. As a comparison, the next-largest sector weighting represents only 11% of the index. In the following chart, we have inverted the price of oil compared with the average credit spread of the overall index. Thus far this year, the strength of the economy and robust earnings have driven credit spreads tighter in other sectors, which has offset much of the widening in the energy sector.
In the U.S. Treasury bond market, the shape of the yield curve flattened last week. Short-term rates rose as investors concluded that the Federal Reserve remained on course to hike the federal-funds rate at its December meeting, while long-term interest rates declined as concerns regarding the sustainability of global economic growth re-emerged. The yield on the 2-year U.S. Treasury bond rose 2 basis points to 2.92%, and the yield on the 5-year increased 1 basis point to 3.04%. In the longer end of the curve, the 10-year declined 3 basis points to 3.18%, and the 30-year decreased 7 basis points to 3.38%. The result was that the spread between the 2-year and the 10-year has compressed to 26 basis points.
Investors keep a close eye on the shape of the yield curve, as historically an inverted yield curve has been an indication of an impending recession. However, while recent economic indicators and forecasts may show a slowing in the rate of economic growth, they are not signifying a contraction. For example, the Atlanta Fed's GDPNow forecast for fourth-quarter GDP growth is 2.9%, which is still a strong growth rate, especially considering the growth rate has averaged 4% for the past two quarters. The shape of the yield curve has been affected by the monetary policies of the major global central banks. After a decade of 0% interest rates, the Fed has embarked on normalizing the federal-funds rate, which has had a significant impact on the short end of the curve. From the first hike in December 2015 through the three rate hikes thus far this year, the federal-funds rate has risen about 200 basis points. Currently, the futures market is pricing in a 76% probability that the Fed will raise the rate another quarter point next month.
In the long end of the curve, several forces have helped drive up interest rates this year. First, inflation has risen to the Fed's targeted rate of 2%. Second, more supply has come on the market as the U.S. government is increasingly selling more debt to fund the deficit and the Fed is selling some of the assets in its portfolio that had been bought as part of its quantitative easing programs. Finally, although supply is increasing, demand for fixed-income securities by the other global central banks is decreasing. The European Central Bank's quantitative easing program is coming to an end in December, and the Bank of Japan's asset-purchase program is expected to dwindle next year as well.
Recent Morningstar Credit Ratings Research
Last week, Morningstar Credit Ratings initiated public rating coverage of Americold Realty Trust (BBB, stable) and published a detailed report outlining our rating rationale. The rating reflects Americold's leadership in the temperature-controlled warehouse business, the experience and sophistication of its management team, and its tenant roster, which is populated with a considerable number of investment-grade tenants that have long working relationships with the real estate investment trust. As well, Americold increasingly demonstrates a sustainable competitive advantage from a number of sources. These considerations are somewhat offset by its relatively small size and its history as a highly leveraged and secured capital structure.
Our telecom, media, and technology team published its Investment-Grade Semiconductor 2019 Credit Outlook. In this report, Michael Dimler, CFA, our senior TMT analyst, highlighted that in his opinion, credit quality for semiconductor firms remains robust. Credit ratings in the semiconductor sector remain buoyed by entrenched competitive advantages that drive strong returns on invested capital and free cash flow. Though he expects growth to slow over the next year or two, he believes conditions remain conducive to further margin expansion. With the less burdensome tax rules governing cash repatriation, companies now have additional flexibility to utilize cash on hand to fund capital needs, reducing the need for external funding.
Our real estate investment trust team published a Corporate Credit Spread Chartbook. In this report, Chris Wimmer, CFA, our senior REIT analyst, opined that REITs specializing in industrial warehouse properties continue to enjoy strong demand in excess of new supply; otherwise, most other sectors are experiencing conditions that suggest the commercial real estate cycle is near the top of the cycle. In his view, investment-grade REITs are not raising any warning signs with respect to their balance sheets. Currently, MCR is not anticipating negative rating pressure in the coming year or two.
As third-quarter earnings season winds down, we published credit notes on Bausch Health (B-, negative), Eli Lilly & Co (AA, stable), AmerisourceBergen (A, stable), and Tenet Healthcare (B-, positive).
Weekly High-Yield Fund Flows
Investors reversed course and returned to the high-yield asset class last week. Net fund inflows were $1.0 billion, consisting of $0.8 billion of net unit creation across high-yield exchange-traded funds and $0.2 billion of inflows among open-end funds. Year to date, total outflows across the high-yield sector have been decidedly negative; investors have pulled $19.5 billion out of the junk bond market. Outflows among open-end funds is $13.6 billion and net unit redemptions in ETFs is $5.8 billion.
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.