The return of volatility
Corporate credit held in reasonably well this week amid an uptick in government bond yields and commodity price volatility. High yield bond prices slipped to begin the week, but stabilized toward week’s end as U.S. economic data reaffirmed that the U.S. Federal Reserve is unlikely to raise interest rates when it meets next week.1 Nevertheless, high yield bonds declined by approximately 0.9% in the week ended September 15, and are on track to deliver the first negative monthly return since January.1 High yield bond mutual funds saw outflows of nearly $2.5 billion in the week ended September 14 following last week’s European Central Bank’s meeting and resulting rise in government bond yields.2,3 Month to date, high yield bonds are providing returns of -0.55%, reversing a small portion of the 13.9% gain experienced since the beginning of 2016.1 Bank loan mutual funds saw their seventh consecutive weekly inflow this week, with the latest $306 million in inflows bringing net inflows to nearly $1.3 billion through July and August.3
This week brought a decline in crude oil prices as the International Energy Agency’s (IEA) September oil report suggested a slight decline in demand growth and a delay in the rebalancing of the oil market until the second half of 2017.4,5 Despite the decline in oil prices, energy credit prices largely held steady this week, with high yield energy bonds declining 0.5% and senior secured energy loans rising by 0.5%.6,7 The IEA lowered its global oil-demand growth forecast by 100,000 barrels per day to 1.3 million barrels per day and said that OPEC oil production rose by 20,000 barrels a day in August to 33.47 billion barrels per day.6 The new data comes amid reduced expectations of a production freeze when OPEC next meets later this month. Nevertheless, energy credit remains one of the better performing sectors, with high yield energy bonds and senior secured energy loans providing year-to-date returns of 28.4% and 20.5%, respectively.7,8 Despite significant yield compression since the beginning of 2016, energy credit continues to trade at a significant discount to the broader credit markets. High yield energy bonds currently yield 8.4%, or 1.8% more than the broader high yield bond market.1,7 Senior secured energy loans currently yield 16.1%, or 10% more than the broader senior secured loan market.4,8
Ahead of Fed Governor Lael Brainard’s speech on Monday, there had been some speculation that she might lay the groundwork for the U.S. Fed to adopt a more hawkish stance.8 Instead, her comments were far more dovish than expected and laid out a case for further “prudence in the removal of policy accommodation.”9 In her comments, Brainard referred to the “new normal” of slow growth and low neutral rate. “Perhaps most salient for monetary policy, it appears increasingly clear that the neutral rate of interest remains considerably and persistently lower than it was before the crisis,” she said.10 Brainard was the last Fed official to speak before the September 20–21 policy-setting meeting and helped to bolster expectations that the U.S. Fed will remain patient in the months ahead.10 This week’s somewhat tepid economic releases provided the last round of data before the FOMC meets, with August’s 0.3% rise in the core Consumer Price Index alone among those potentially supportive of an increase in the federal-funds rate.11 Other data, including a decline in U.S. retail sales and industrial production, continues to point to some ongoing slack in the U.S. economy.12,13 With a September rate hike likely off the table, next week’s FOMC meeting will provide a new “dot plot” and fresh insight into how the U.S. Fed views the economy. In March and June, every Fed official was expecting at least one rate hike in 2016.14 Investors will be looking to next week’s release to determine whether there has been a reevaluation of that outlook.
Chart of the week: Loans' relative value
- High yield bonds have returned nearly 13.9% year to date, well outpacing returns on major U.S. investment-grade credit and equity indices.1,15
- During this same timeframe, the yield on high yield bonds has declined approximately 352 basis points, to just 6.57% from a peak of 10.09% in February 2016.1
- Senior secured loans’ year-to-date return of 6.92% has caused yields for the asset class to compress since the beginning of the year to approximately 6.19%.4
- As the chart above highlights, high yield bonds’ spread over senior secured loans has declined more than 160 basis points from its recent cyclical peak of 183 basis points in January 2016 and currently sits at just 20 basis points. This is well below its long-term average of approximately 99 basis points.1,4
1 Bank of America Merrill Lynch High Yield Master II Index.
2 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
3 Thomson Reuters Lipper.
4 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
5 International Energy Agency, http://bit.ly/1ylJ2td.
6 Bank of America Merrill Lynch High Yield Energy Index.
7 Credit Suisse Leveraged Loan Index (energy component).
8 Barrons, http://on.barrons.com/2cfl5Uf.
9 U.S. Federal Reserve, http://bit.ly/2cLo4Fp.
10 Bloomberg based on CME data.
11 U.S. Department of Labor, http://bit.ly/1jOrHr7.
12 U.S. Department of Commerce, http://bit.ly/Y4FaTF.
13 U.S. Federal Reserve, http://bit.ly/1PAnoR7.
14 U.S. Federal Reserve, http://bit.ly/2cjs4fh.
15 Bank of America Merrill Lynch U.S. Corporate Master Index and S&P 500 Index.
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.