Hunt for yield
Corporate credit markets continued to benefit from the rally in oil prices, low global interest rates and accommodative central bank policy this week. High yield bond and senior secured loan prices improved as investors continue to migrate toward higher-yielding corners of the market as the rally in government bonds around the world perpetuates the need for income. High yield bond prices moved higher through much of the week before losing some momentum toward week’s end amid a late-week downturn in equities. Nevertheless, high yield bonds extended their streak of weekly gains, returning approximately 1.14% in the week ended June 9.1 With the benchmark index off to a solid start in June, high yield bonds are now providing year-to-date returns of more than 9.4%.1 It was a similar story for senior secured loans, with the asset class posting another weekly gain as bank loan mutual funds reported a fifth weekly inflow over the past six weeks.2 Although more modest than high yield bonds, senior secured loan returns are more than 4.55% year to date and are off to the best start to any year since 2009.3 Amid rising prices and a slight uptick in refinancing activity, the average yield for senior secured loans continues to trend lower. After peaking at approximately 7.7% in mid-February, average yields have since tightened to 6.3%.4 Despite the recent decline, senior secured loan yields remain about 30 basis points above their five-year average.4
With oil prices having rallied approximately 54% since January and closing above $50 a barrel for three consecutive days this week, energy credit continues to drive the rally in high yield bonds and senior secured loans.5 Year to date, high yield energy bonds have returned approximately 22.3%, after returning -23.6% in 2015 and -7.5% in 2014.6 By price, high yield energy bonds currently stand at around 86.1% of face value, or nearly 20% below where they stood in June 2014.6 Senior secured energy loans also continue to benefit from oil’s recent recovery and have led the rally seen in the asset class over the past month. This week brought another uptick in senior secured energy loan prices. Investors looked past the first increase in weekly U.S. oil output in 13 weeks and last week’s rise in rig count to focus on ongoing supply outages and expectations that supply and demand could soon move back toward balance.7,8 Senior secured energy loans have returned 11.85% so far this year—the best-performing sector in 2016 to date save the metals and mining sector, which has returned 14.38%.9
Following the unexpectedly soft nonfarm payrolls report the previous week, residual concerns about global growth re-emerged this week. U.S. Fed Chair Yellen’s speech in Philadelphia on Monday gave no indication of a central bank in any rush to raise interest rates.10 Instead, the Fed Chair delivered another round of dovish comments, repeating that the economy remained in an expansion phase but refraining from providing any details around the timing of the Fed’s next rate hike. As for May’s employment report, she acknowledged that it was disappointing, but noted that “one should never attach too much significance to any single monthly report.”10Nevertheless, the speech could be taken as a reaffirmation that a June rate hike is off the table and that a July rate hike is now perhaps off the table as well. Fed funds futures told the tale, as the likelihood of a rate hike during the June 14–15 FOMC meeting fell to 0%.11 Meanwhile, both the yield on the U.S. 10-year Treasury note and the U.S. 30-year Treasury bond declined to a 2016 low, as falling global bond yields set off another wave of buying by investors in their ongoing search for yield.12,13
Chart of the week: Zero chance
- Following last Friday’s weak jobs figures and Fed Chair Yellen’s subsequent dovish remarks in Philadelphia on Monday, investors have come to ascribe a 0% probability that the FOMC will raise the Fed funds rate at its June 14–15 meeting.11
- For context, the figure is a stark decline from the 22% implied probability of a rate hike just one week earlier and a 95% implied probability in December 2015. Looking to the July meeting, the implied probability of a rate hike dropped from 55% on June 2 to 20% one week later.11
- With the sudden reintroduction of a dovish Fed narrative, yields on the U.S. 10-year Treasury note dropped to a 2016 low and yields on 10-year government bonds in Germany and the UK hit record lows.14
- While government bonds around the world trended lower, the credit markets rallied as investors cheer what appears to be continued accommodative conditions. Within such an environment, however, investors may continue to face difficulty finding meaningful sources of income.
1 Bank of America Merrill Lynch High Yield Master II Index.
2 Thomson Reuters Lipper.
3 Credit Suisse Leveraged Loan Index.
4 Credit Suisse Leveraged Loan Index (based on a three-year maturity).
5 Federal Reserve Bank of St. Louis, http://bit.ly/1pqqax4.
6 Bank of America Merrill Lynch High Yield Energy Index.
7 U.S. Energy Information Administration, http://1.usa.gov/1Fke1JG.
8 Baker Hughes, http://bit.ly/1elov2d.
9 Credit Suisse Leveraged Loan Index (energy component).
10 U.S. Federal Reserve, http://1.usa.gov/1OaNlXm.
11 Bloomberg based on CME data.
12 Federal Reserve Bank of St. Louis, http://bit.ly/1TZywnM.
13 Federal Reserve Bank of St. Louis, http://bit.ly/1MViNEQ.
14 The Wall Street Journal, http://on.wsj.com/1YhAxkm.
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