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Credit Insights

Credit Spreads Rally on Jobs Report

But market rebound isn't enough to offset losses experienced earlier in the week.

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Markets rebounded sharply Friday in response to a surging payroll report; however, the rise was not enough to offset many of the losses experienced earlier in the week. The average spread in the Morningstar Corporate Bond Index tightened 2 basis points Friday, but even including that gain, credit spreads widened to +118 from +115 on a week-over-week basis. The S&P also surged higher Friday but ended down 0.75% on a weekly basis. While the high-yield market weakened at the beginning of the week, it was one of the few asset classes that improved on a weekly basis. The average spread in the Bank of America High Yield Master II Index tightened 13 basis points Friday and ended the week at +429. Even though our weekly fund flows calculation showed that more than $1.6 billion of assets were redeemed from high-yield mutual funds and exchange-traded funds through Wednesday night, we suspect that the combination of strong employment growth and wide credit spreads will prompt investors to return to this asset class and inflows will resume this week.

Economic releases at the beginning of last week were modestly weaker than expected and prompted many investors to reassess their expectations for continued economic growth. For example, while manufacturing reports continued to indicate economic expansion, the levels declined from prior reports. In addition, pending homes sales edged down and auto sales were lackluster. All of these reports were quickly forgotten Friday morning when the payroll report surged higher, prior payroll reports were revised higher, and the unemployment rate fell to its lowest postrecession level. However, Robert Johnson, Morningstar's director of economic analysis, cautioned that he thought the markets were reading too much into this one jobs report. While he acknowledged the report was good, he did not think it was as great as the headline figure indicated. For instance, the report benefited from seasonal factors and the inclusion of 20,000 workers who had been on strike returning to their jobs. In addition, hourly wages inched down. Johnson also thinks the falling unemployment rate, low level of initial unemployment claims, and wage growth in select professions may lead to spot labor shortages in 2015. In this scenario, wages in these professions may increase and pressure corporate earnings, especially for companies that have a high labor component in their cost base. The increase in jobs and the declining unemployment rate will also probably pressure the Federal Reserve to begin raising its federal funds rate sooner than later. The increase in wages, along with our expectation for rising interest rates and the recent increase in the foreign exchange value of the U.S. dollar, could begin to pressure corporate margins next year.

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

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