Go with the flow
Senior secured loans continued to benefit from the reflation trade that has driven markets since the U.S. presidential election. This week, the asset class saw another uptick in prices as U.S. equities hit fresh records, U.S. Treasury yields remained near 2016 highs, and bank loan mutual funds saw another large weekly inflow.1 Inflows into bank loan mutual funds continue to gain momentum as investors appear to be reaching for investments whose values are less sensitive to rising interest rates. At $1.8 billion, inflows into bank loan mutual funds during the week ended December 7 were among the highest on record and continue a string of positive weekly fund flows.2 Following inflows of $9.7 billion in the second half of 2016, net inflows into bank loan mutual funds now stand at $3.1 billion for the full year 2016 versus outflows of $21.6 billion and $23.9 billion in 2015 and 2014, respectively.1 Following a 10th consecutive positive monthly return in November, floating rate senior secured loans are off to a strong December. Month to date, the asset class is providing returns of 0.53% driven, in part, by continued outperformance across the commodities sectors.3 Notably, energy senior secured loans have shown the strongest month-to-date gains, returning approximately 1.6% in the week ended December 8.4
High yield rally
As 10-year government bonds capped their worst month in seven years, high yield bond prices weakened toward November’s end.5,6 However, high yield bonds have since rallied and are also off to a strong December. Month to date, the asset class is providing returns of approximately 1.2% after returning -0.39% in November.5 Fund flows for the week ended December 7 reflect renewed risk appetite, with investors putting more than $2.0 billion into high yield bond mutual funds and extending a string of three consecutive weekly inflows into the asset class.1 Similar to senior secured loans, high yield bond returns have been, in part, driven by a rally in high yield energy bonds. Month to date, high yield energy bonds have returned approximately 2.6%, bringing year-to-date total returns to 37.3%.7 So far in December, high yield bonds are providing returns of approximately 1.2%, outperforming investment grade bonds (0.12%), 10-year U.S. Treasury notes (-0.15%) and 30-year U.S. Treasury bonds (-1.3%).4,5,8,9
Next week: Fed
U.S. Treasury yields rose on Thursday after the European Central Bank said it would scale back its monthly bond purchase program to €60 billion from €80 billion beginning next April.10 The decision to slow purchases was widely viewed as a first step toward the end of the ECB’s quantitative easing program, sending the yield on the 10-year German bund above 0.4% for the first time since January after spending much of the third quarter in negative territory.11 Despite the surprise reduction in size, ECB President Draghi left the door open for further bond purchases in the event inflation fails to pick up, while also expanding the types of assets the central bank can purchase.10 The ECB’s decision comes just one week before the U.S. Federal Reserve’s December 13–14 policy-setting meeting. With a 25 basis point rise in short-term interest rates already priced in, investors will be looking to next week’s Fed statement and updated economic projections for further signals about the expected number of rate hikes in 2017 and whether the U.S. central bank’s assessment of the U.S. economy has changed materially since it met on November 1–2.12,13 Since then, U.S. economic data has shown ongoing strength in the labor markets and consumer confidence, while long-term interest rates have spiked on the back of a slight increase in global inflation expectations.8,14,15
Chart of the week: LIBOR on the rise
- Since late June 2016, three-month LIBOR has climbed approximately 33 basis points, reaching its highest point since 2009 and quickly working its way toward the important 1.00% mark.16 LIBOR is a particularly important financial marker as it is one of the most widely used benchmarks for short-term interest rates and is tied to trillions of dollars of consumer and commercial loans, including the senior secured loan market.
- 92% of today’s senior secured loan market is priced with a LIBOR floor, which has provided many of the loans issued since late 2009, a period during which LIBOR has remained below 1.00%, with a minimum LIBOR index level.17 Of that 92%, virtually all of the loans’ floor (94%) is set at 1.00%.2
- If LIBOR breaches the 1.00% threshold, much of the senior secured loan market would reprice with it in the following months, potentially providing senior secured loan investors with increased income alongside a potential rise in interest rates.
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Thomson Reuters Lipper.
3 Credit Suisse Leveraged Loan Index.
4 Credit Suisse Leveraged Loan Index (energy component).
5 Bank of America Merrill Lynch U.S. 10-year Treasury Index.
6 Bank of America Merrill Lynch High Yield Master II Index.
7 Bank of America Merrill Lynch High Yield Energy Index.
8 Bank of America Merrill Lynch U.S. Corporate Master Index.
9 Bank of America Merrill Lynch U.S. 30-year Treasury Index.
10 Reuters, http://reut.rs/2hd6ZpO.
11 The Wall Street Journal, http://on.wsj.com/2hbC2j2.
12 Bloomberg, based on CME data.
13 U.S. Federal Reserve, http://bit.ly/2fSAY5v.
14 U.S. Department of Labor, http://bit.ly/1gck641.
15 The Conference Board, http://bit.ly/1eu7yyH.
17 J.P. Morgan High Yield and Leveraged Loan Morning Intelligence, December 1, 2016.
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