Declining interest rates propped up investment-grade bonds but couldn't offset the pummeling high yield received from dramatically widening credit spreads.
Dave Sekera: Investment-grade corporate bonds performed well last month in spite of widening credit spreads due to declining interest rates; however, high-yield bonds were pummeled as the dramatic widening in credit spreads in that asset class more than offset the benefit of lower rates.
In the investment-grade market, the Morningstar Corporate Bond Index rose a little more than 0.5% and, year to date, is now only down 9 basis points. The average spread of our index widened 10 basis points to 188 over Treasuries in September, but the decline in interest rates more than offset the credit spread widening. Thus far in October, credit spreads have begun to rebound. As of Oct. 7, our index stands at a spread of 178.
In the high-yield market, the Bank of America/Merrill Lynch High Yield Index fell by 2.5% in September as the average spread of the index widened 92 basis points to a spread of 662. High-yield bonds have also recovered sharply in early October and have declined to a spread of 632. Year to date, the high-yield index has dropped 1.1%.
Part of the reason that interest rates declined is that the Federal Reserve decided the time still wasn't right to begin normalizing monetary policy and held the federal-funds rate at near zero percent. Within the Fed's statement, most of its references to the U.S. economy were positive. In fact, Bob Johnson, Morningstar's director of economic analysis, recently increased his GDP forecast for 2015 to a range of 2.2% to 2.6%. He specifically indicated that he thought the final growth rate for the year will come in near the top end of his range. However, economic growth in Europe remains sluggish, and it is especially unclear how quickly economic activity in China is slowing.
The Fed specifically indicated that these international factors were a major influence in its decision to hold its policy steady. We doubt the Fed will take any action in conjunction with the October meeting; but if our view on economic growth in the U.S. is accurate for the remainder of the year, then the swing factor at the December meeting will continue to be determined by international dynamics.
