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Credit Insights

Investment-Grade Corporate Credit Spreads Rise to Widest Level in Three Years

Crude oil prices fall to lowest level since credit crisis.

Corporate credit spreads in the investment-grade bond market widened further last week. Investors looked to reduce risk exposures in light of slumping commodity prices and heightened uncertainty driven by China's devaluation of its currency. The average spread of the Morningstar Corporate Bond Index, our proxy for the investment-grade market, widened 5 basis points to +169 basis points over Treasuries. This is almost 30 basis points wider than where the index closed last year and is the widest level that the index has registered since September 2012, when the markets were recovering from the first incarnation of the Greek debt crisis and resulting European bank solvency concerns. Year to date, our investment-grade bond index's return is negative 0.20%. The decline in bond prices due to the combination of widening credit spreads and slightly higher underlying interest rates has more than offset the amount of underlying yield generated thus far this year.

Last week, China allowed the value of its currency to decline versus the U.S. dollar by about 3%. While the nominal change was not great in absolute terms, it occurred very rapidly, especially for a currency whose trading range is tightly controlled by the Chinese government. The devaluation is most likely a symptom of the rapidly slowing economic growth in the Chinese economy and indicative of significant capital outflows by foreign investors. The devaluation should help stem the decline of Chinese exports as these goods will now be cheaper compared with foreign currencies. In our view, the devaluation probably won't have much of a direct impact on the U.S. economy, as very little of that economy is based on exports, and of those exports, only a small amount is directed to China. In fact, over the medium to long term, the U.S. economy will most likely benefit from the lower commodity prices that have resulted from the slowdown in the Chinese economy. Although the Chinese economy appears to be cooling and the European economy remains stagnant, the U.S. economy continues its positive momentum. Robert Johnson, Morningstar's director of economic analysis, highlighted that economic data, such as retail sales, inventories, and construction data, has been revised upward over the past few weeks. In his opinion, this means that the next revision to the second-quarter GDP report may be an unusually large increase. Economic growth in the second quarter was originally reported at 2.3% and may be revised to 3.0%-3.5%. This positive momentum has carried through to the beginning of the third quarter, as the retail sales and industrial production reports were quite positive.

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