The corporate credit markets posted small gains during a somewhat quiet week ahead of the Labor Day weekend. For high yield bonds, this week capped off the seventh straight month of positive gains for the asset class, returning approximately 2.23% in August amid ongoing central bank accommodation and improved commodity prices.1 High yield energy, chemicals and metals and mining bonds remained some of the better performers. High yield energy bonds returned approximately 4.28% in August even as oil prices experienced some increased volatility towards month’s end.2 For senior secured loans, a return of 0.79% in August marked the asset class’s sixth straight monthly gain and its best performance for the first eight months of any year since 2012.3 Year to date, senior secured loans have generated returns of approximately 6.53%, led by strong gains across the commodity sectors.3 Year to date, energy senior secured loans and metals and mining senior secured loans have returned 18.92% and 23.35%, respectively.4,5 Driven by rising LIBOR (London Interbank Offered Rate) and the ongoing search for yield, senior secured loans have experienced increased inflows in recent weeks. This week saw the fifth consecutive weekly inflow into bank loan mutual funds, bringing net inflows to $643 million in August even as flows into high yield bond mutual funds turned negative.6
Friday’s nonfarm payrolls report, the last before the U.S. Federal Reserve’s September monetary policy decision, capped off a week of mixed economic data. With an increase of 151,000, the August change in nonfarm payrolls was somewhat of a disappointment against economist expectations of 180,000.7 While lower than anticipated, its impact on markets was tempered by expectations that the U.S. economy was unlikely to create jobs at the same pace following the particularly strong gains of June and July. Below the headline jobs growth figure, in August, the unemployment rate held steady at 4.9%, the labor force participation rate was unchanged at 62.8%, and average hourly earnings rose by 3 cents to $25.73.7 While the report threw a potential rate hike at September’s FOMC policy meeting further into doubt, it was viewed as solid enough to make a credible case for a rate hike in the near-term. Financial markets acted accordingly, with the U.S. dollar and U.S. government bond yields immediately declining and U.S. equities rising higher.8,9,10 Notably, federal-funds futures now indicate a lower probability of a rate hike in September.11 However, the probability of a rate hike in December remained steady at 55%.11
While the nonfarm payrolls report was the marquee event of the week, the U.S. Federal Reserve will likely take notice of other economic data released this week. While U.S. Fed Chair Yellen’s remarks in Jackson Hole, Wyoming, and subsequent remarks from other U.S. Fed officials seemed to signal that a September rate hike remained squarely on the table, financial markets have continued to register doubt.12 Beginning the week higher, U.S. government bond yields moved mostly lower throughout the week as manufacturing data, productivity growth and measures of inflation appeared to suggest that the Fed would be in no hurry to raise rates.9 On Thursday, the Institute for Supply Management said that U.S. manufacturing activity fell to a level indicating a contraction in August, and the Labor Department lowered its second quarter estimate of nonfarm productivity growth.13,14 Earlier, the Commerce Department said core inflation as measured by the PCE index was unchanged at 1.6% for the fifth straight month and lowered its estimate of second quarter GDP growth to 1.1%.15,16 So, even if the labor market continues to show signs of tightening, other economic data remains somewhat subdued, which is likely to factor into any rate decision over the short-term.
Chart of the week: LIBOR surge
- Three-month LIBOR (London Interbank Offered Rate) rose to 84 basis points this week, the highest level since 2009, perhaps as a result of new SEC rules governing money market funds that are scheduled to take effect in October.17
- One of the most widely used benchmarks, LIBOR impacts the rate on trillions of dollars of debt, including commercial paper, student loans, mortgages, as well as senior secured loans.
- With the majority of the senior secured loan market featuring LIBOR floors of 100 basis points or higher, LIBOR has yet to rise high enough to affect the rates on most senior secured loans. However, LIBOR’s recent surge is enough to add incremental yield to at least a portion of the senior secured loan market.18
- Currently, 22% of all senior secured loans have LIBOR floors of 75 basis points or below. Above that, 68% of all senior secured loans have LIBOR floors of 100 basis points.18
- This means that if LIBOR remains above 75 basis points in the coming months, nearly one-quarter of the senior secured loan market will be reset at higher rates. Should LIBOR rise above 100 basis points, 90% of the senior secured loan market will be reset higher.18
1 Bank of America Merrill Lynch High Yield Master II Index.
2 Bank of America Merrill Lynch High Yield Energy Index.
3 Credit Suisse Leveraged Loan Index.
4 Credit Suisse Leveraged Loan Index (energy component).
5 Credit Suisse Leveraged Loan Index (metals and mining component).
6 Thomson Reuters Lipper.
7 U.S. Department of Labor, http://www.bls.gov/news.release/empsit.nr0.htm.
8 Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/TWEXB.
9 Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/DGS2.
10 Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/SP500.
11 The Wall Street Journal, http://www.wsj.com/articles/markets-becalmed-ahead-of-u-s-jobs-report-1472801991.
12 U.S. Federal Reserve, https://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm.
13 Institute for Supply Management, https://www.instituteforsupplymanagement.org/ismreport/mfgrob.cfm.
14 U.S. Department of Labor, http://www.bls.gov/news.release/prod2.nr0.htm.
15 U.S. Department of Commerce, http://www.bea.gov/newsreleases/national/pi/2016/pdf/pi0716.pdf.
16 U.S. Department of Commerce, http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.
17 Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/USD3MTD156N.
18 S&P Global Market Intelligence, S&P LSTA Leveraged Loan Index.
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