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Credit Insights

Deluge of New Issues Pressures Corporate Credit Spreads

New issue supply starting to overwhelm demand.

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The corporate bond market experienced a bout of indigestion last week. For the third week in a row, the new issue market was exceptionally strong as more than $50 billion worth of new bonds were priced. Even though there continues to be strong demand for corporate bonds, this amount of supply, in conjunction with the weakening equity markets and falling oil prices, caused credit spreads to widen. In the investment-grade market, the Morningstar Corporate Bond Index widened 6 basis points to end the week at +134. High-yield corporate bonds widened even further as the Bank of America Merrill Lynch High Yield Master Index widened 26 basis points to +468. With oil prices falling back toward their lows, the energy sector was one of the worst-performing sectors, as it widened 13 basis points in the investment-grade market and 37 basis points in the high-yield market. As the equity market sank, investors rotated assets in the Treasury market, which pushed yields on 5-, 10-, and 30-year Treasury bonds down by 12-14 basis points.

Even though corporate credit spreads widened last week, corporate bonds should remain well bid over the next few months. As the European Central Bank's asset-purchase program prints new money to purchase sovereign bonds and asset-backed securities, the path of least resistance will be to reinvest those proceeds in corporate bonds. Considering the all-in yield on European bonds is much lower than in the United States and the U.S. dollar continues to strengthen versus the euro, global investors have been reallocating principal to the U.S. market. Much of the recent demand in the U.S. corporate bond market has been attributed to foreign investors in developed markets looking to pick up the higher all-in yield U.S. corporate bonds offer and invest in the safety of the strengthening dollar. Highlighting this differential in yields, the spread between the 10-year U.S. Treasury and 10-year German bund remains near its historically widest level at +185 basis points. In addition, the Bank of Japan continues to weaken the yen with its own asset-purchase plan which has prompted some Japanese fixed-income investors to also reallocate their asset mix to the U.S. corporate bond market.

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