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Credit Insights

Fed's Lowered Projections Not a Surprise

A lower inflation forecast may provide room for further monetary accommodation or quantitative easing, but the amount of room the Fed has to maneuver is still limited.

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The G20 and FOMC failed to make any substantive policy changes last week, but after bottoming out early last Monday morning, Spanish and Italian bonds rallied strongly throughout the rest of the week. Both dropped to levels comparable to those seen prior to the Spanish bank bailout announcement. This movement allowed the strong underlying demand for corporate bonds to outweigh concerns over either sovereign risk or slowing economic indicators. The Morningstar Corporate Bond Index tightened six basis points to +210 and the Morningstar Eurozone Bond Index tightened three basis points to +239 last week.

We continue to recommend a neutral weighting on corporate credit and favor bonds issued by U.S. over European issuers. While the decrease in these sovereign yields is encouraging in the short term, we still doubt that the sovereign debt crisis--and the contagion effect it could have on corporate credit spreads--has been resolved. We believe that losses need to be realized, not covered up, and the structural issues across the EU's labor and regulatory regimes need to be resolved before the long-term situation will improve.

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

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