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Credit Insights

Weaker Economic Expectations in Europe Pressure Corporate Bond Market

Following the brief sell-off at the end of last year, investors have had a steady appetite for risk assets thus far this year. As an indication of investors' comfort in taking on greater risk in order to reach for yield, long-beleaguered Greece returned to the public bond markets in the middle of last week and was able to issue EUR 2.5 billion of 10-year bonds at a yield of 3.90%. The demand for the new issue was almost 5 times oversubscribed, with reportedly EUR 11.8 billion worth of orders for the new notes. This was the first 10-year bond offering priced by Greece since before the 2011-12 Greek debt crisis. After years of working to improve its creditworthiness, Greece has been making a comeback in the public capital markets; earlier this year, it successfully priced EUR 2.5 billion of 5-year notes at 3.60%.

However, after steadily rallying for much of the year to date, many risk asset markets pulled back last week. Part of the reason for the pullback was dour news out of Europe. Following the European Central Bank's meeting Thursday, the governing council announced that it kept its key interest rates unchanged and expects that those rates will remain at current levels through at least end of this year. The reason for the continued easy monetary policy of negative interest rates for the foreseeable future was that the ECB lowered its forecast for 2019 GDP to 1.1% from 1.7%. In addition, the ECB lowered its GDP forecast for 2020 to 1.5% from 1.6% and held its forecast steady for 2021 at 1.5%. To bolster the economy during this softening patch, the ECB also announced that it will restart its targeted longer-term refinancing operations in order to increase liquidity in the European Union. On the basis of the lower growth estimates, the ECB reduced its inflation forecasts. It now forecasts inflation of only 1.2% in 2019 compared with its prior forecast of 1.6%. The ECB lowered its 2020 and 2021 inflation forecasts to 1.5% and 1.6% from its prior expectations of 1.7% and 1.8%, respectively.

Between the lower economic growth and reduced inflation expectations, European investors rotated out of stocks and into sovereign bonds. Most of the main European stock indexes fell about 1%, whereas sovereign government bonds rallied. As bond prices rose, the yield on the German 5-year note fell 8 basis points to negative 0.35%, and the yield on the German 10-year bond declined 11 basis points to 0.07%. While still in positive territory, this is the lowest yield that the German 10-year has traded at since September 2016. The Swiss 10-year bond, another safe-haven investment, rallied, which pushed the yield down 12 basis points to negative 0.34%. Even though the Swiss 10-year has rarely traded with a positive yield since 2014, this is the most negative yield since September 2016.

U.S. Treasury bonds also traded higher across the curve, sending their respective yields down to interest rates that rival their lowest levels since early last year. The 2-, 5-, 10-, and 30-year bonds fell by 9, 13, 12, and 11 basis points respectively to 2.46%, 2.43%, 2.63%, and 3.01%. Although investors flocked to the safety of the U.S. Treasury bond market, that same sentiment did not carry through to the corporate bond market, and credit spreads widened out. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade corporate bond market) widened 3 basis points to end the week at +127. In the high-yield market, the average spread of the ICE BofAML High Yield Master II Index widened 32 basis points to +418.

The week ended on a sour note after Chinese stocks plunged overnight before the U.S. trading session opened Friday. The Shanghai Index fell 4.40% on Friday following a report from a Chinese investment bank opining that the Chinese stock market had become overheated after having risen over 20% since the beginning of the year. But even after this pullback, the Shanghai Index remains up 19% year to date.

Recent Morningstar Credit Ratings Research Reports
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