Relative value
The corporate credit markets continued to improve this week as U.S. equities rose to fresh highs and the global search for income drove investors to higher-yielding corners of the market. For the week ended August 11, high yield bonds returned approximately 1.1% driven by strong gains in the energy, chemicals and the metals and mining sectors.1 After rising in each of the past nine trading sessions, high yield bond prices are currently sitting at 12-month highs.1 The failure of the Bank of England to buy as many bonds as it wanted Tuesday rippled across bond markets, causing yields on 10-year U.K. government bonds to decline to historic lows and shorter-dated U.K. bonds to trade in and out of negative territory.2 With approximately $11.7 trillion worth of sovereign bonds now trading with negative yields, flows into the relatively higher-yielding U.S. corporate bond market have remained relatively steady throughout 2016.3 Year to date, U.S. investment-grade corporate bond mutual funds have seen inflows of more than $64 billion.4 This has helped drive yields on investment-grade bonds to approximately 2.8% from 3.7% as of year-end 2015.5 High yield bonds have seen a similar type of yield compression, with a net $8.8 billion of inflows into high yield bond mutual funds in 2016 helping to push yields down to 6.6% from over 10.0% in February.1,3 For senior secured loans, a year-to-date return of 6.0% has caused average yields for the asset class to decline a more modest 1.3% from the beginning of 2016 to approximately 6.2%.6

Retail sales
Although last week’s stronger-than-anticipated nonfarm payrolls report sparked thoughts that the U.S. Federal Reserve could move to raise interest rates in September, this week’s data may support the lower-for-longer narrative.7 Friday saw U.S. retail sales for the month of July coming in below expectations and U.S. producer prices in July declining the most since September 2015.8,9 A moderation in consumer spending and tame inflation tempered expectations that the U.S. Federal Reserve will rush to raise interest rates soon, sending yields on the U.S. 10-year Treasury note to below 1.5% for the first time this month.10 Earlier in the week, a weaker-than-expected report on productivity growth had already put a damper on interest rate expectations. Nonfarm business productivity – the goods and services produced by American workers per hour – declined by 0.5% in the second quarter.11 It was the third consecutive quarterly decline, the longest streak since 1979, and extends a period of low productivity growth that began in 2007. While theories to explain the slowdown vary (e.g., low business investment or simple mismeasurement), productivity growth has been slowing for almost a decade. Since 2007, the annual rate of productivity growth has averaged approximately 1.2%, down from about 2.6% between 2000 and 2007. Since 2010, it has been even lower, at about 0.6%.11

Slowing productivity
While other signs are pointing to an improving U.S. economic outlook, including ongoing labor market strength and nascent signs of wage growth, slow productivity growth is one force that could keep interest rates low over the longer term. In minutes from its June 14–15 policy meeting, the U.S. Federal Reserve noted the impact that slow productivity growth would have on interest rates going forward. “Participants cited a number of factors that pushed down their projections of the longer-run rate, including domestic and global demographic trends and weaker productivity growth, which together imply a slow pace of trend output.”12 The U.S. Federal Reserve has already lowered its expectations for future growth and interest rates, in part, due to weaker productivity.13 In 2012, Fed officials forecast the U.S. economy to grow by between 2.3% and 2.5% and for the federal-funds rate to level off at 4.25% over the longer term. As of June, their median projections were for 1.8% to 2.0% growth and a federal-funds rate of 3.0% to 3.3% over the long run. While quarterly productivity figures are volatile, persistently low productivity growth could potentially lead to slower U.S. economic growth and lower interest rates over the long run.

Chart of the week: Global crude oil rebalancing

  • Crude oil returned to the headlines this week, with prices experiencing significant swings – first down, then up – and driving much of the week’s strong performance in credit and equity markets.14
  • The U.S. Energy Information Administration reported on Wednesday that domestic inventories of crude oil increased by 1.1 million barrels from a week earlier to “historically high levels for this time of year.”15 One day later, the International Energy Agency revised global oil demand growth down by 100,000 barrels per day, but also noted that it sees no concerns of oversupply during the second half of 2016.16,17
  • While these sometimes-competing data points are important drivers of daily price movements, it is important to note that the larger story of normalization within the oil market’s supply-demand dynamic remains intact.
  • To this end, the global oil surplus contracted more than 50% year over year through the second quarter of 2016 and is forecast to enter deficit territory by the third quarter of 2017 as the chart highlights.18 A decline of approximately 1.2 million barrels per day in non-OPEC output against steady consumption growth of 1.5% since mid-2015 is driving supply and demand closer to balance.19

1 Bank of America Merrill Lynch High Yield Master II Index.
2 Bloomberg,
3 J.P. Morgan High Yield and Leveraged Loan Morning Intelligence, August 8, 2016.
4 Thomson Reuters Lipper.
5 Bank of America Merrill Lynch Corporate Master Index.
6 Credit Suisse Leveraged Loan Index.
7 U.S. Department of Labor,
8 U.S. Department of Commerce,
9 U.S. Department of Labor,
10 Federal Reserve Bank of St. Louis,
11 U.S. Department of Labor,
12 U.S. Federal Reserve,
13 U.S. Federal Reserve,
14 St. Louis Federal Reserve Bank,
15 U.S. Energy Information Administration,
16 International Energy Agency,
17 The Wall Street Journal,
18 U.S. Energy Information Administration,
19 International Energy Agency,

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