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Credit Insights

Credit Spreads in Corporate Bond Market Hold Steady

Futures market is already pricing in additional Fed rate hikes.

The corporate bond market started last week on a weak note, and credit spreads widened slightly on Monday and Tuesday. However, the market turned around and credit spreads began to tighten Wednesday afternoon after the Fed raised the federal funds rate. The new issue market remained quiet, and without any new issues to satisfy demand, credit spreads in the secondary market tightened over the latter half of the week. The corporate bond indexes ended the week at about the same place as they began. The Morningstar Corporate Bond Index, our proxy for the investment-grade bond market, was unchanged at +123, and the Bank of America Merrill Lynch High Yield Master Index widened 2 basis points to +391.

Futures Market Pricing In Additional Fed Rate Hikes
According to data from the CME, the federal funds futures market-implied probability that the Federal Reserve will hike the federal funds rate after the June meeting is 58%. The probability that the federal funds rate will be over 100 basis points after the December meeting is 90%. Additionally, the market-implied probability that there will be two more rate hikes this year is 58%. While the Fed is tightening monetary policy in the United States, the European Central Bank has held its course and remains in an easy monetary policy stance. Earlier this month, the ECB decided to keep its short-term interest rates at negative yields and will maintain its EUR 60 billion monthly purchase program through year-end. However, ECB President Mario Draghi recently alluded to signs of strengthening in the eurozone and the re-emergence of inflation. Many investors took this to mean that the ECB is edging closer to dialing back its dovish monetary policy.

High-Yield Outflows Surge
Outflows among high-yield mutual funds and exchange-traded funds surged to $5.2 billion last week, the single-greatest weekly outflow recorded since mid-2014. The withdrawals were evenly split between open-end mutual funds and ETFs. This follows $2.2 billion of outflows the prior week, spurred by the decline on oil prices. As oil prices sank below $50 per barrel, investors in the high-yield market looked to reduce risk, specifically among issuers in the energy sector. Investors remain especially skittish regarding the energy sector after having suffered significant losses when oil prices dropped precipitously in the second half of 2015 and early 2016. Oil prices recovered some of the prior week’s losses, but still closed below the $50 psychological hurdle Friday.

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