Corporate Bond Market Comes Back to Life

Market Data and Insights

Corporate credit spreads have fully recovered from the panic that gripped the corporate bond markets in early 2016 when oil and commodity prices were hitting multi-year lows. Both the average spread of the Morningstar Corporate Bond Index and the Bank of America Merrill Lynch High Yield Master Index have tightened to multi-year lows, touching the tightest levels that credit spreads have traded at since mid-2015. Within the indexes, energy and basic materials have been some of the best performing sectors year-to-date as oil prices have recovered to back over $50 per barrel and commodity prices in general have risen off their lows and stabilized.

After rising the prior week, interest rates declined last week and returned to the same levels they traded at two weeks ago. The yield on the 5-year Treasury declined 5 basis points to 1.24%, the yield on the 10-year fell 7 basis points to 1.73%, and 30-year decreased 8 basis points to 2.48%. Part of the impetus for interest rates to decline was driven by commentary from ECB President Mario Draghi after the ECB’s October monetary policy meeting. With the prospect of the Fed potentially raising the federal-funds rate in December, market participants were beginning to become more concerned about the possibility of tighter global monetary policy. However, these concerns were partially put to rest as the ECB appears to be poised to continue to supply additional liquidity to the global bond markets. Draghi specifically stated that the ECB’s monthly asset purchase program would continue to run through March 2017 as scheduled. Further, he stated that a sudden stop to the quantitative easing program “is not in anybody’s mind.” Considering the ECB pledged to continue its full EUR80 billion per month asset purchase program and is not contemplating an immediate stop to the program at the end of March, then it appears that there remains a much longer runway of monetary stimulus to come.

The new issue corporate bond market began to come back to life last week after slowing markedly in early October. As corporations have begun to release their earnings reports and exit their quiet periods, many management teams have looked to capitalize on the combination of low interest rates and tight credit spreads. With the U.S. presidential election closing in fast, many CFOs may look to lock up funding before any heightened uncertainty may impact the new issue window to the market. In addition, several large acquisitions remain that will require a substantial amount of funding in the debt capital markets. For a list of issuers that we believe may look to tap the debt capital markets in the near term, please refer to our Oct. 20, 2016, publication, “Potential New Issue Supply.”

High yield fund inflows slipped into negative territory last week as $300 million of funds were pulled from open end mutual funds and ETF’s. However, as compared with typical amount of fund flows, this amount is not meaningful enough to indicate a change in the trajectory of the market. With third-quarter earnings still in early stages, it appears that the market is taking a wait and see attitude to hear from management teams as to the outlook for the fourth quarter before making any investment decisions prior to either committing additional funds or withdrawing funds from this asset class.

- source: Morningstar Analysts

- source: Morningstar Analysts