The lack of surprises in the first-quarter earnings season helped.
Volatility in the asset markets has been steadily declining and is nearing new lows. One factor helping to suppress volatility is the lack of many surprises in the first-quarter earnings season, which passed with results generally within the range of expectations. From an economic point of view, while GDP was weak in the first quarter, it is expected to rebound in the second quarter. For example, the Atlanta Federal Reserve Bank's GDPNow forecasting tool projects a 3.6% expansion in the second quarter. Merger and acquisition activity has been generally quiet over the past few weeks, although we may see a rebound this summer. Even geopolitical risk has quieted down. As markets expected, Emmanuel Macron won the French election, Brexit negotiations have not begun, the European Central Bank is maintaining its quantitative easing policy, and the rhetoric surrounding North Korea has calmed.
David Sekera, CFA, is managing director of corporate bond ratings and research for Morningstar Credit Ratings, LLC.
Following the French presidential election and the general lessening of international tensions, corporate credit spreads have tightened and asset volatility has declined toward its lowest levels. For example, the average spread of the Morningstar Corporate Bond Index has been held to a 7-basis-point trading range over the past four weeks. In the equity market, the CBOE Volatility Index (which measures market expectations for near-term volatility as conveyed by S&P 500 stock index option prices) declined to as low as 9.8 on May 8. While this may not be a historical low, there have been only three instances since 1990 in which the index has registered lower. Market volatility and corporate credit spreads have been highly correlated over time. Based on the average spread of the Morningstar Corporate Bond Index since 1990, the VIX and investment-grade credit spreads have an r-squared of approximately 85%.
The average corporate credit spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) tightened 3 basis points last week to +117, a new low for the year. The last time the index was at this level was September 2014. From a longer-term perspective, the average spread of the Morningstar Corporate Bond Index has been lower less than one fourth of the time since the end of 1999. In the high-yield market, the Bank of America Merrill Lynch High Yield Master Index tightened 5 basis points to +377. The tightening was led by the energy sector, which declined 10 basis points as oil prices continued to rise. Since the end of 1999, the average spread of the high-yield index has been tighter only 17% of the time.
Although corporate credit spreads tightened and volatility remained near its historical lows, fund flows for high-yield open-end mutual funds and exchange-traded funds suffered net withdrawals last week. According to our data, a total of $1.9 billion was withdrawn from the sector. The withdrawals were predominantly in the ETF sector, which experienced an outflow of $1.8 billion, whereas the open-end mutual fund sector recorded withdrawals of only $0.1 billion.
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