Corporate Bond Market Continues to Recapture Losses
The demand for corporate bonds should push corporate credit spreads tighter, says Morningstar's Dave Sekera.
The Morningstar Corporate Bond Index rose 0.50% last week based on a combination of tightening corporate credit spreads and declining interest rates. The average spread in the Morningstar Corporate Bond Index tightened 2 basis points to +136 and the yield on the 10-year Treasury bond declined 11 basis points to 2.50%. In our third-quarter corporate credit outlook published in September, we outlined why we thought corporate credit investors were poised to begin recapturing their losses suffered this summer, and we continue to think the corporate bond market will recover more in the short term. At its lowest point, the Morningstar Corporate Bond Index had declined 4.62% this year through Sept. 5, but has recaptured a substantial amount of that loss since then and is now only down 1.00%.
Interest rates are likely to continue to decline as a result of the Federal Reserve's ongoing asset-purchase program, while the demand for corporate bonds should push corporate credit spreads tighter. With fund flows into bond funds returning to positive territory and the Fed's quantitative easing increasingly removing Treasuries and mortgage-backed bonds from circulation, demand for corporate bonds will continue to improve. We expect corporate credit spreads will be pushed to the bottom of this year's trading range, which was +129 on May 15. The Fed's asset-purchase program will probably push the 10-year Treasury into a 2.25%-2.50% trading range until the market begins to believe, once again, that we are coming close to when the Fed will begin to taper. At that time, interest rates will quickly rise, as they did last summer, toward levels that are closer to historically normalized levels based on current inflation and inflation expectations.
David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.