In a week dominated by central bank activity, corporate credit markets continued to trend higher as the Bank of Japan and U.S. Federal Reserve monetary policy decisions remained supportive of ongoing accommodation.1,2 Despite the potential for a rate hike in December, both high yield bonds and senior secured loans benefited from the U.S. Fed’s latest signal that the future path of interest rate hikes will likely remain both slow and gradual.2 With U.S. equities rising and the U.S. dollar declining, financial markets appeared more focused on the U.S. Fed’s longer-run outlook than the improved odds of a rate hike before year-end.3,4 Reflecting U.S. Fed policy and ongoing foreign demand, U.S. government bonds flattened across the curve, with the yield premium between the two-year and 10-year note falling to its lowest level in nine years.5 High yield bonds returned approximately 0.88% in the week ended September 22, erasing all the declines sustained in September and putting the asset class back on track to its eighth consecutive monthly gain.6 Senior secured loans returned 0.29% during the week ended September 22, and are now providing returns of approximately 7.23% in 2016.7 By comparison, high yield bonds have returned approximately 14.8% and the S&P 500 has returned approximately 7.8% year to date.3,6
Helped by a drop in U.S. inventory levels and a weaker U.S. dollar, oil prices gained ahead of next week’s OPEC meeting.8 Although hopes of a deal to curb output have largely faded, oil prices benefited from a third consecutive weekly decline in U.S. inventory levels. The U.S. Energy Information Administration said U.S. crude oil stockpiles declined by 6.2 million barrels in the week ended September 16, helping to drive crude oil prices above $46 per barrel for the first time in nearly two weeks.9 Since rising above $50 per barrel in June, oil prices have remained range-bound between $40 and $50 per barrel through August and September.8 With oil prices providing a degree of stability, energy credit remains one of the better-performing sectors in September. Month to date, high yield energy bonds and senior secured energy loans are currently providing month-to-date returns of approximately 0.6% and 2.0%, respectively.10,11 Year to date, high yield energy bonds, senior secured energy loans and the S&P 500 energy index are providing returns of approximately 29.4%, 21.1% and 14.9%, respectively.10,11,12
As expected, the Federal Open Market Committee (FOMC) left the federal-funds target rate unchanged at its September 20–21 policy-setting meeting, while leaving the door open for a rate increase before year-end.2 The statement noted a pickup in U.S. economic growth, rising household spending and a strengthening labor market, stating that the “near-term risks to the economic outlook appear roughly balanced.”2 In what was perhaps a compromise between those Fed officials who wanted to raise rates on Wednesday and those who are in no hurry to raise short-term interest rates, the committee judged “that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress towards its objectives.”2 This “hawkish no-hike” came with all the usual caveats, allowing for the possibility that the Fed’s resolve could evaporate if the economic data does not cooperate between now and December. The “dot plot,” which charts Fed officials’ interest rate projections, pointed to a lower path for interest rates, with policy makers now anticipating only one rate hike in 2016, two in 2017 and three in 2018 and 2019.13 In June, they had projected two rate increases in 2016 and three in 2017.14 This change in the dots partly reflects changes to the economic forecast, with Fed officials now expecting long-term growth to settle at 1.8%, down from the 2.0% they were projecting in June.13,14
Chart of the week: Slow and low
- In keeping with what has become a familiar script in 2016, the Federal Reserve maintained the target federal-funds rate on Wednesday. As it has in many of its communications throughout the year, the Fed’s statement noted that it would “wait for further evidence of continued progress toward its objectives” before raising interest rates.2
- Markets cheered as both the Fed and the Bank of Japan reassured investors once again this week that they would, at least for now, keep in place the easy monetary policies of recent years.1,2 As the chart highlights, the FOMC has gradually, but consistently, lowered its expectations for where the federal-funds rate will be in the coming years and over the long term.15
- The FOMC’s expectation for longer-term rates has declined by more than 60 basis points since its September 2015 meeting; market expectations through 2018 remain anchored well below those of the Fed.2
- Continued expectations for sluggish economic growth underlie both the Fed’s and investors’ expectations for longer-term interest rates. At this week’s meeting, for example, members of the FOMC lowered their median projection for longer-run economic growth by another five basis points from its assessment at June’s meeting, to just 1.8%. Longer-run projections of economic growth have now fallen from 2.00% in September 2015 and from as high as 2.65% in June 2011.
1 The Wall Street Journal, http://on.wsj.com/2csWn34.
2 Federal Reserve, http://bit.ly/2cRagsl.
3 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
4 Federal Reserve Bank of St. Louis, http://bit.ly/2dn26Gw.
5 The Wall Street Journal, http://on.wsj.com/2dggS5N.
6 Bank of America Merrill Lynch High Yield Master II Index.
7 Credit Suisse Leveraged Loan Index.
8 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
9 U.S. Energy Information Administration, http://bit.ly/1Fke1JG.
10 Bank of America Merrill Lynch High Yield Energy Index.
11 Credit Suisse Leveraged Loan Index (energy component).
13 Federal Reserve, http://bit.ly/18vNShI.
14 U.S. Federal Reserve, http://bit.ly/1UPqboZ.
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