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Credit Insights

Corporate Spreads at Precrisis Levels

But from a fundamental viewpoint, we think the preponderance of credit spread tightening has run its course.

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After grinding tighter for the past five months, corporate credit spreads have returned to their tightest levels of the year and in fact are at their tightest levels since before the 2008-09 credit crisis. The average spread in our index tightened 3 basis points last week to +127. In our fourth-quarter market outlook, published Sept. 25, we highlighted our expectation that corporate credit spreads would be pushed toward the bottom of the trading range over the past year. Now that we are back at the tights, it appears that in the short term, the path of least resistance is tighter still. However, from a fundamental viewpoint, we think the preponderance of credit spread tightening has run its course.

Across our coverage universe, our credit analysts generally have a balanced view that corporate credit risk will either remain stable or improve slightly, but that the tightening in credit spreads on those names will probably be offset by an increase in idiosyncratic risk (debt fund M&A, increased shareholder activism, and so on). However, this could rapidly change if the Federal Reserve begins to reduce its asset-purchase program, which could lead to an increase in long-term interest rates. In that case, we would expect a repeat of last summer's chain of events in May and June. Corporate credit spreads quickly widened out as portfolio managers looked to sell long-term bonds to reduce their portfolios' duration and dodge the brunt of losses from rising yields.

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

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