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Credit Insights

Corporate Bond Market Has More Room to Recover

With the government back to work and the debt ceiling suspended, the political rhetoric emanating from Washington will subside and allow investors to concentrate on third-quarter earnings and fourth-quarter forecasts.

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In our third-quarter corporate credit outlook published Sept. 25, we outlined why we thought corporate credit investors were poised to begin recapturing their losses suffered this summer. Since then, the Morningstar Corporate Bond Index has risen 1.12% and is now down only 1.49% year to date. We continue to think the corporate bond market will recover in the short term. Interest rates are likely to continue to decline due to the Federal Reserve's ongoing asset-purchase program, and the demand for corporate bonds will push corporate credit spreads tighter. Fund flows into bond funds have returned, and as the Fed's asset purchases remove Treasury and mortgage-backed bonds from circulation, demand for corporate bonds has improved. Last week, this increased demand helped to reduce the average credit spread in the Morningstar Corporate Bond Index by 5 basis points to 138 over Treasuries.

We continue to believe that from a long-term fundamental perspective, corporate credit spreads are fairly valued in the current trading range. However, over the near term, because of the Fed's quantitative easing program providing a steady flow of liquidity into the markets, we expect corporate credit spreads will probably be pushed to the bottom of this year's trading range. The tightest credit spread in our index reached +129 on May 15. Across Morningstar's coverage universe, our credit analysts generally hold a balanced view that corporate credit risk will either remain stable or improve slightly, but that tightening credit spreads will generally be offset by an increase in idiosyncratic risk (debt-funded M&A, increased shareholder activism, and so on).

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

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