Right again
The corporate credit markets righted themselves following three days of post-Brexit vote declines as the initial surprise of Britain’s decision to leave the European Union wore off. After declines sustained in the immediate aftermath, high yield bond prices and senior secured loans strengthened the final few trading days of the month to end June in the black. With equities continuing to recoup losses and the CBOE Volatility Index unwinding last week’s 50% spike, high yield bonds and senior secured loans posted only mild declines in the week ended June 30.1 Following a 1.08% return in June, high yield bonds have now provided a positive return in each of the past five months.2 Through the first six months of 2016, high yield bonds have returned approximately 9.3% following a decline of 4.6% in 2015.2 Notably, high yield energy and the metals and mining sectors continue to lead the high yield rally, with the sectors providing year-to-date returns of approximately 22.5% and 26.7%, respectively.3,4 Following mild declines in January and February, senior secured loans have generated a positive return in each of the last four months and are now providing year-to-date gains of 4.23%.5 While senior secured loans have seen significant yield compression over the past six months, at 6.51% the asset class is currently yielding 0.41% more than its five-year average.6

Further cuts
In his speech on Thursday, Bank of England Governor Mark Carney said the central bank is prepared to take additional steps to safeguard the British economy and hinted at further interest rate cuts to come. Re-emphasizing that the Bank of England stands ready to provide more than £250 billion in additional liquidity to support the financial system, Carney also said that “some monetary policy easing will likely be required over the summer.”7 He also spoke of “increased uncertainty” and “tighter financial conditions” and described a weather vane that sits atop the Bank of England, which was once used to determine whether the wind was moving up or down the Thames. Now, the central bank “has identified the clouds on the horizon and can see that the wind has now changed direction,” he said, pointing to slower economic growth and lower interest rates ahead. While his remarks set off a global rally in equities, the British pound fell further and the yield on the 10-year U.K. note declined to a new all-time low of below 0.9%.8

Rate reset
While the direct impact of the U.K. vote on the U.S. is expected to be limited, it has reinforced the view that interest rates will likely remain lower for longer and introduced the potential for further market volatility ahead. This week brought another major reset in global interest rates, with more than $13 trillion of negative yield sovereign bonds now driving the global search for yield.9 With global bond yields plumbing new lows, yields on the U.S. 30-year and 10-year U.S. Treasuries declined to an all-time low on Friday.10,11 These declines are thought not to reflect a growing concern about the state of the U.S. economy, but a technical reaction to accommodative monetary policies around the world. This week’s economic data reinforces the notion that the U.S. economy remains a bright spot in an otherwise sluggish global economy. Expectations of stronger U.S. GDP in the second quarter were reinforced by another monthly pickup in U.S. consumer spending, while first quarter U.S. GDP was revised higher.12,13 Nevertheless, expectations of a rate hike by the U.S. Fed have only continued to decline in the days since the British referendum. Nevermind July or September, federal funds futures now put the odds of a rate hike at either of the U.S. Fed’s next two meetings at only 2%, and are not pricing in the next increase to short-term interest rates until 2018.14

Chart of the week: Steady as she goes

  • Credit prices declined in sympathy with equity and commodity markets in the immediate aftermath of last week’s Brexit vote. High yield bond prices, for example, declined approximately 1.4% in the three days immediately following the vote before beginning to recover.15 Prices on senior secured loans also declined, but experienced a significantly milder fall of approximately 0.53% over the same three-day span.16
  • This week’s price activity has generally been in line with each asset class’s broader historical pattern, in which prices of senior secured loans have shown lower volatility than those of high yield bonds during periods of market stress.17
  • At just 4.3%, the average standard deviation of daily price movements of senior secured loans is less than one-third of the average standard deviation of high yield bonds’ price changes (13.7%) between June 2012 and June 2016—reflecting a higher level of price volatility for bonds versus loans.
  • Further, the standard deviation of high yield bond prices has jumped to nearly 40% on three separate occasions since June 2012; the highest it has reached for senior secured loan prices during the same time period is just 16.4%.3

1 Federal Reserve Bank of St. Louis, http://bit.ly/295DSwP
2 Bank of America Merrill Lynch High Yield Master II Index
3 Bank of America Merrill Lynch High Yield Energy Index
4 Bank of America Merrill Lynch High Yield Metals/Mining Index
5 Credit Suisse Leveraged Loan Index
6 Credit Suisse Leveraged Loan Index (based on a three-year maturity)
7 Bank of England, http://bit.ly/298ANjO
8 The Wall Street Journal, http://on.wsj.com/29a0bVk
9 Credit Suisse, CS Credit Strategy Daily Comment, June 30, 2016
10 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp
11 Federal Reserve Bank of St. Louis, http://bit.ly/29ecFfc
12 U.S. Department of Commerce, http://1.usa.gov/1cr2Y9e
13 U.S. Department of Commerce, http://1.usa.gov/1eZ44Hx
14 Bloomberg, using CME Group data
15 Bank of America Merrill Lynch High Yield Master II Index
16 Credit Suisse Leveraged Loan Index
17 Thomson Reuters Middle Market Weekly, data based on the period from June 2012 through June 2016

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