Exuberant Equities Fail to Excite Corporate Bond Market
After suffering from the sharp increase in interest rates and widening credit spreads this summer, investors are hesitant to pay tighter credit spreads for longer-dated corporate bonds.
Even though the equity market is hitting all-time highs, this exuberance has not rubbed off on the corporate bond market. Since the beginning of September, when the 10-year Treasury peaked at almost 3%, the S&P 500 has risen 8.6% to a new high, whereas the average credit spread in our corporate bond index has only tightened 12 basis points to +135, which is still 6 basis points wider than the tightest level reached in May. After suffering from the sharp increase in interest rates and widening credit spreads this summer--due to the expectation that the Federal Reserve was going to begin tapering in the fall--investors are hesitant to pay tighter credit spreads for longer-dated corporate bonds.
Based on Fed vice chair Janet Yellen's testimony and responses to questioning at her confirmation hearing in the Senate, we don't expect the Fed to begin tapering its asset-purchase program anytime in the near future. With the Fed continuing to purchase mortgage-backed securities and long-term Treasury bonds, investors have increasingly fewer fixed-income assets from which to choose. This decrease in supply is becoming even more pronounced as the U.S. government's deficit is shrinking and requiring less new debt issuance. This has positively affected the demand for corporate bonds as the supply of available fixed-income securities constricts and the new Fed-provided liquidity looks for a home. So long as the Fed's asset-purchase program is running full speed ahead, it will provide a ceiling as to how much long-term rates can rise and will help push credit spreads tighter over time. As such, we expect that credit spreads will continue to grind tighter.
David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.