Welcome to the New Morningstar.comSee what's new
Credit Insights

Volatility-Induced Turbulence Subsides

Dave Sekera, CFA

The volatility-induced turbulence that spread into the corporate bond market in early February subsided last week as equity prices rebounded sharply. The S&P 500 rallied 4.30% and recovered well over half of its recent downturn. As the equity markets soared and volatility dwindled, investors exited flight-to-safety trades, which pushed short-term interest rates higher. In the corporate bond market, investment-grade corporate credit spreads generally held their ground while high-yield spreads tightened considerably. In the investment-grade market, investors balanced the desire to purchase corporate bonds at wider spreads with wanting to avoid the negative impact of rising interest rates, which will offset the benefit of the wider corporate credit spreads.

The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) widened 1 basis point to +98 basis points. In the high-yield market, the BofA Merrill Lynch High Yield Master Index tightened significantly as the average spread of the index declined 32 basis points to end the week at +350. As the markets normalized throughout the week, it drove a risk-on sentiment, which prompted investors to chase riskier assets higher. Whereas the investment-grade market is more correlated with the Treasury bond market in the short term, the high -yield market has historically been much more correlated with the equity markets. High-yield bonds are much less sensitive to movements in underlying interest rates because a significantly larger portion of the total return in the high-yield market is driven by credit spreads. High-yield credit spreads represent a much larger portion of total return for the asset class as opposed to the investment-grade sector, where much less of the total return is driven by the credit spread.