Investor Demand for Corporate Bonds Leads to Further Credit Spread Tightening
Weekly high-yield fund flows normalize after prior week's surge.
Investor demand for corporate bonds continued to push credit spreads tighter last week. In the investment-grade bond market, the average spread of the Morningstar Corporate Bond Index tightened 2 basis points to +128. In the high-yield market, the spread of the ICE BofAML High Yield Master II Index tightened 20 basis points to +412. While investors were willing to pay slightly tighter credit spreads for high-quality bonds, the amount of credit spread tightening lagged the movement in lower-quality bonds. Typically, short-term movement in the investment-grade bond market is correlated with changes in interest rates. As U.S. Treasury prices softened last week, investors were unwilling to chase spreads at tighter levels. In addition, according to Bloomberg, a heavy dose of new issue supply in the primary market—over $38 billion—provided enough new bonds to fill demand. Between the holiday-shortened week and issuers already completing their financing requirements following the exit from quiet periods after releasing earnings, Bloomberg forecasts that new issue supply will decrease to a more normalized range this week of $20 billion-$25 billion.
While market technical factors precluded investment-grade bonds from tightening much further, these same factors did not hold back the high-yield market. Historically, short-term movement in the high-yield bond market has been more closely correlated with changes in the equity market, and last week was no exception. Not only did the S&P 500 climb 2.50%, but many European markets rose even more. For example, Germany's DAX rose 3.60% and the French CAC rose 3.86%. One of the factors that helped boost global equity markets was the rumor that weakening economic activity in the European Union may spur the European Central Bank to restart its quantitative easing program. Another factor was the opinion that the Federal Reserve probably won't raise the federal-funds rate for the rest of the year.