Corporate Bond Markets Pull Back as Trade Negotiations and Public Posturing Raise Tensions
Investors decided to sell first and ask questions later.
Global asset markets took it on the chin last week as investors decided to sell first and ask questions later. As the Trump administration and the Chinese government traded barbs through the media and over Twitter, the political posturing and rhetoric took its toll on investor confidence. Investors are starting to become concerned that the two countries may not be able to negotiate realistic trade terms in a reasonable time frame, which could lead to global economic weakening. In the U.S. equity market, the S&P 500 fell 2.18% last week. In China, the Shanghai Index dropped 4.52%. European investors were also caught up in the fray as Germany's DAX dropped 2.84%, the French CAC declined 3.99%, and the U.K. FTSE fell 2.40%. In the corporate bond market, the average credit spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade corporate bond market) widened 5 basis points to end the week at +120. The ICE BofAML High Yield Master II Index widened 29 basis points to +401.
While corporate credit spreads widened out and equity markets sold off, Treasury bonds and high-quality sovereign bonds played their typical safe-haven role and traded higher as investors looked to escape volatility in risk assets. In the United States, the yields on 2-, 5-, and 10-year bonds each dropped 6 basis points to 2.27%, 2.26%, and 2.47%, respectively, as bond prices rose. In Europe, negative interest rates were not enough to dissuade investors from flocking to Germany's sovereign bonds as prices rose enough to push Germany's 5-year bond to a yield of negative 0.47% and the 10-year bond to negative 0.05%. Germany's 5-year bond is trading at its most negative yield since April 2017; for context, the most negative yield that Germany's 5-year has traded at was negative 0.62% in July 2016.
Even after this pullback, the equity markets are not all that far off their all-time highs, and as we showed in last week's Credit Research Highlights, corporate credit spreads remain near the tightest quartile that they have traded at over the past 20 years. Year to date, the average spread in the investment-grade market has tightened 37 basis points; in the high-yield market, it has tightened 132 basis points. As one Wall Street trader said last week, "If investors were really worried about the trade negotiations, then credit spreads would be a lot wider." Year to date, the tightening of credit spreads and decrease in underlying interest rates have driven the investment-grade index 5.58% higher and the high-yield index 8.31% higher.
Weekly High-Yield Fund Flows
Institutional investors took a little money off the table across the high-yield asset class last week, whereas individual investors dipped their toes into the water. Exchange-traded funds are typically looked upon as a proxy for institutional investor demand while open-end funds are the realm of individual investors. Among ETFs, net unit redemptions totaled $0.5 billion, which was only partially offset by net inflows of $0.1 billion, resulting in total outflows of $0.4 billion.
Year to date, total inflows into the high-yield asset class are $16.0 billion, consisting of $8.5 billion worth of net unit creation among the high-yield exchange-traded funds and $7.5 billion of inflows across the high-yield open-end mutual funds. However, inflows year to date have still not been enough to offset the outflows this asset class suffered during the fourth quarter of 2018. Over the past 52 weeks, total outflows equaled $2.1 billion, driven by $5.4 billion of withdrawals across open-end mutual funds as ETFs have recuperated their outflows and more and have seen a total of $3.4 billion in new unit creation.
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