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Credit Insights

Credit Spreads Rally Tighter, but Bond Prices Fall as Interest Rates Rise

Barring a re-emergence of the sovereign debt crisis or some other global calamity, interest rates will probably continue to head higher over the near to medium term.

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The credit market resumed its rally last week as corporate credit spreads tightened 6 basis points on average, with the Morningstar Corporate Bond Index dropping to 183 basis points over Treasuries. We think credit spreads will continue to constrict over the next few months and may tighten back to last April's levels (+134). However, prices on corporate bonds declined as the rise in interest rates more than offset the credit spread tightening. For example, the 10-year Treasury bond widened out 30 basis points to 2.30%. While we don't make explicit interest rate forecasts, it appears to us that barring a re-emergence of the sovereign debt crisis or some other global calamity that drives a flight to Treasuries, interest rates will probably continue to head higher over the near to medium term.

The preponderance of the increase in interest rates began soon after the Fed released its statement after the Federal Open Market Committee meeting. In the statement, the Fed highlighted that it is seeing further economic improvement (moving to "moderate" from "modest") and strains in the global financial markets have eased. In addition, the Fed acknowledged rising inflationary pressures as it noted the recent rise in crude oil and gasoline prices, although it continues to believe that longer-term inflation expectations are stable.

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David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.