The corporate bond rally that started in earnest last fall continues to grind along. The Morningstar Corporate Bond Index tightened another 7 basis points over the past week to +188, nearly 80 basis points tighter than the widest point witnessed last October. Though spreads are now tighter than they've been since last August, they remain well wide of the levels seen a year ago.
We expect that developments across Europe will dictate whether credit markets head sharply higher or lower from here. News on this front was largely positive over the past week, with the German government signing off on the second round of Greek aid, European Union leaders agreeing to new fiscal restraints, and sovereign yields continuing to fall. In addition, the European Central Bank's latest long-term refinancing operation, offering cheap three-year financing to banks, attracted a level of demand that was spot-on with expectations. With EUR 530 billion added to the banking system, near-term liquidity concerns amongst European banks have been put to rest. Yet demand wasn't so strong to stoke fears that liquidity problems are, in fact, worse than feared.
But Europe still has a ways to go before the debt crisis is firmly in the rearview mirror. EU leaders will be watching the pending Greek private debt exchange closely this week before giving the final signoff to the new bailout. Successful execution of the debt exchange offer, which expires Thursday, could give credit markets another boost. Longer term, however, economic woes continue to weigh on the region, making it difficult to bring deficits down. Spain, for example, announced Friday that it will probably miss its budget target for 2012.
In the United States, solid economic data overall also continues to support the corporate credit market. While manufacturing data were notably weak--perhaps owing to a larger-than-normal budget flush in late 2011--several items point to a strengthening U.S. consumer. Weekly jobless claims reached the lowest level since the recession, while February auto sales hit a seasonally adjusted annual rate of 15.1 million units, a post-recession peak. Retail same-store sales and pending home sales data also point to a more optimistic consumer.
With the threat of a fresh downturn easing, weaker firms most susceptible to recession have seen spreads tighten the most recently. The spread gap between nonfinancial A- and BBB-rated issuers in the Morningstar Index currently stands at about 140 basis points, down from nearly 220 basis points last fall and 180 basis points at the start of the year. We've seen a sizable pickup in high-yield issuance recently as a result. Notably, US-based Sprint Nextel (S), which has a B+ rating, surprised the market last week with a $2 billion bond offering. The firm had previously indicated that the $4 billion it raised last November would be sufficient to meet its needs.
This chart illustrates how the spread between A- and BBB- issuers has changed over time.
