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Credit Insights

Corporate Bond Rally Resumes

Corporate bond markets resumed their rally across the investment-grade and high-yield markets last week. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade corporate bond market) tightened 4 basis points to end the week at +124. In the high-yield market, the average spread of the ICE BofAML High Yield Master II Index tightened 19 basis points to +386. However, while investors snapped up corporate bonds, Treasury bond prices fell across the yield curve. The yield on 2- , 5-, 10-, and 30-year Treasury bond yields rose by 6, 9, 10, and 10 basis points respectively, to 2.55%, 2.56%, 2.75%, and 3.12%. Equities generally rose as the S&P 500 increased 0.39% and most European indexes increased close to 1% for the week (except for the U.K. FTSE, which dropped as investors are increasingly worried that a hard Brexit is rapidly approaching).

Among economic indicators released last week, the initial reading for fourth-quarter 2018 GDP reported an annualized 2.6% growth rate. That was a sharp drop from 3.4% realized in the third quarter of 2018 but better than Street consensus expectations of 2.2%. The better-than-expected number helped to buoy markets, but the rate of GDP growth appears to continue to slow. Based on the current economic metrics released over the past few weeks, the Atlanta Fed's GDP Now model estimate for the first quarter of 2019 is an annualized 0.3% growth rate.

This past week, the Institute for Supply Management released its February manufacturing index reading. The index level dropped to 54.2 from a 56.6 reading in January, which was lower than consensus forecasts. The decline suggests that manufacturing slowed in February compared with January; however, while the decrease in the index is concerning, a level above 50 continues to register economic expansion rather than contraction. Similarly, the Manufacturing Purchasing Managers' Index reading dropped to 53.0 from 54.9. Economic activity in February was hampered by a combination of exceptionally cold weather in the Midwest, contagion from slowing growth in China, economic weakness in Europe, and heightened uncertainty from ongoing trade disputes.

The other major economic report released last week was the Bureau of Economic Analysis' personal income and outlays for December and January. Personal income rose a healthy 1.0% in December, although it retreated 0.1% in January. Personal consumption expenditures fell 0.5% in December and the personal saving rate rose to 7.6%. The core reading of the personal consumption expenditures index, the Federal Reserve's main inflation gauge, held steady at 1.9%, near the Fed's 2% inflation target. With economic metrics signaling that the U.S. economy may be slowing in reaction to even slower global economic growth and inflation remaining near the Fed's target, Capital Economics, a leading economic research provider, forecasts that the Fed's monetary policy will remain on hold for now. Capital Economics also expects that later this year, the Fed will end its program to let its balance sheet reserves run off, which would leave the size of its asset holdings at approximately $3.5 trillion. Capital Economics expects the next monetary policy move the Fed will make will be a cut to interest rates.

Weekly High Yield Fund Flows: Institutional Investors Return to High-Yield Market, but Individuals Remain on Sidelines
Institutional investors have dipped a toe back into the waters of the high-yield market, but individual investors have shied away. Net inflows into the high-yield sector totaled $0.6 billion last week; however, all of the inflows were accounted for by exchange-traded funds, as there was a very slight outflow across open-end mutual funds. Historically, ETFs have been viewed as a proxy for institutional managers looking for a quick way to get exposure in a specific asset class, which also provides a liquid market for a quick exit; open-end mutual funds are viewed as a proxy for individual investors with a more buy-and-hold mindset.

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