Flat to slightly better
With declining U.S. equities and rising U.S. Treasury yields as a backdrop, corporate credit remained relatively stable this week as high yield bonds and senior secured loans rose slightly in the week ended October 13.1,2 High yield bond returns were flat on the week as high yield bond mutual funds saw a mild outflow following two consecutive weekly inflows totaling more than $3.4 billion.3 Month to date, high yield bonds are providing returns of approximately 0.34% as investors continue to show a willingness to move down the credit ratings spectrum in search of yield.1 For reference, lower-rated bonds have continued to outperform their higher-rated counterparts, with CCC rated bonds providing year-to-date returns of approximately 30.4%.4 By comparison, B rated and BB rated bonds are providing year-to-date returns of approximately 14.9% and 12.6%, respectively.5,6 Strong returns have coincided with significant yield compression, with CCC rated bond yields having declined to a 13-month low of 12.7% from more than 21.6% back in mid-February.7 For senior secured loans, prices continued to trend higher, with the asset class providing a modest positive return this week.2 Bank loan mutual funds posted their 11th consecutive weekly inflow and third-straight weekly inflow above $400 million.3 Month to date, senior secured loans have returned 0.15%, bringing year-to-date total returns to 7.79%.2 By comparison, high yield bonds and the S&P 500 have returned 15.7% and 6.47%, respectively, for the year.1,8
Investors were looking to the minutes from the U.S. Federal Reserve’s September meeting for further clues on the path of U.S. interest rates and to provide insight into the internal debate over the timing of the next increase.9 Divisions within the Federal Open Market Committee (FOMC) increased at last month’s meeting, with three regional bank presidents dissenting from the decision to hold off on raising rates.10 The minutes were largely in line with expectations, however, and offered little new information. Proponents of raising rates argued that the U.S. economy is nearing full employment and inflation is likely to move higher, while opponents noted some ongoing slack in the labor market and worried that inflation would remain below target.9 From the minutes: “It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation.”9 The compromise appeared to be to provide a rationale for standing pat in September, but signaling that a rate increase was likely before year end, with participants describing the decision as a “close call” and suggesting that a rate hike could come “relatively soon.”9
U.S. economic data released in the weeks since the September FOMC meeting have been relatively solid, with last week’s nonfarm payrolls report showing rising wages and jobless claims remaining at multi-decade lows.11 This week, data showed total U.S. retail sales rebounding in September, rising 0.6% month over month, and the producer-price index increasing 0.3% month over month.12,13 Amid signs of growing consumer spending and a slight firming of inflation, the market-implied expectation of a December rate hike has increased over the past few weeks. Federal fund futures now show a 66% probability that the U.S. Fed will raise interest rates in December, its highest level since the central bank raised rates in December 2015.14 U.S. Treasury yields climbed alongside this shift in monetary policy expectations, with the yield on the 10-year Treasury note rising to a four-month high before pulling back slightly after China’s September trade report came in below expectations.15,16 With two more employment reports before the U.S. Fed’s December meeting, other near-term catalysts include next week’s Consumer Price Index, third quarter GDP figures and a handful of speeches ahead of the Fed’s blackout period for public comments beginning October 25.17,18
Chart of the week: Declining production
- After a mid-summer swoon, oil prices have now climbed more than 27% from their lows of early August, moving from approximately $39 to more than $50 per barrel.19 Prices first showed signs of upward movement in their current cycle based on speculation ahead of OPEC’s September meeting in Algiers that its members would agree to a production freeze.
- Prices reacted positively after the meeting even though OPEC members only agreed on the need to cut production and left the fine details of such an agreement for its meeting in November.20
- Prices firmed up further on Monday when Russian President Putin added his support for curbing petroleum output.21 Russian participation is an important component of any potential deal because Russia is among the world’s largest producers of petroleum, behind only the United States and Saudi Arabia.22
- While a longer-term balance between supply and demand remains elusive – the International Energy Agency noted in its Oil Market Report for October that global oil supply rose while growth in demand slowed – signs of progress toward an eventual equilibrium continue to emerge.23
- As the chart highlights, the U.S. Energy Information Administration reported this week that crude oil production in the lower 48 states fell below the 8 million barrel per day mark for the first time since June 2014.24 Production is now more than 1.2 million barrels per day lower than its June 2015 peak.24
1 Bank of America Merrill Lynch High Yield Master II Index.
2 Credit Suisse Leveraged Loan Index.
3 Thomson Reuters Lipper.
4 Bank of America Merrill Lynch High Yield CCC and Lower Rated Index.
5 Bank of America Merrill Lynch High Yield B Rated Index.
6 Bank of America Merrill Lynch High Yield BB Rated Index.
7 Bank of America Merrill Lynch High Yield CCC and Lower Rated Index (yield-to-worst).
8 RFederal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
9 U.S. Federal Reserve, http://bit.ly/2ebmOJX.
10 U.S. Federal Reserve, http://bit.ly/2cVCnDx.
11 Bloomberg, http://bloom.bg/2dce2yd.
12 U.S. Department of Commerce, http://bit.ly/Y4FaTF.
13 U.S. Department of Labor, http://bit.ly/1esdPSr.
14 Bloomberg based on CME data.
15 Federal Reserve Bank of St. Louis, http://bit.ly/2aAmG9p.
16 MarketWatch, http://on.mktw.net/2eklmbV.
17 Bloomberg, http://bloom.bg/1Dl6vPO.
18 U.S. Federal Reserve, http://bit.ly/1Sp3Prg.
19 West Texas Intermediate Cushing Crude Oil Spot Price.
20 OPEC, http://bit.ly/2dB2Ub2.
21 The Wall Street Journal, http://on.wsj.com/2dQRHV0.
22 Energy Information Administration, http://www.eia.gov/beta/international/.
23 International Energy Agency, http://bit.ly/2dOam3p.
24 U.S. Energy Information Administration, http://bit.ly/2eaIXfA.
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