Corporate credit continued to respond to the ongoing rally in U.S. equities, an improved outlook for the U.S. economy, and a reset in interest rates that saw the yield on the U.S. 10-year Treasury note rise to its highest level in more than two years.1 High yield bonds provided a modest gain during the week of December 15, as the slightly more hawkish tone struck during this week’s U.S. Federal Reserve’s policy-setting meeting sapped some of the momentum sustained over the past two weeks.2 High yield bond mutual funds recorded an inflow of $3.75 billion for the week ended December 14, the fourth consecutive weekly inflow and the third largest of 2016.3 Year-to-date flows into high yield bond mutual funds now stand at nearly $7.4 billion after investors withdrew a combined $40 billion from the asset class in 2014 and 2015.3 Senior secured loan prices rose throughout the week, as investors appear to be seeking out investments whose values are less affected by a shift in interest rates.4 Month to date, senior secured loans are providing returns of 0.84% and are up more than 1.43% since the U.S. presidential election.4 Continuing a string of large weekly inflows, bank loan mutual funds recorded an inflow of more than $1.5 billion this week as investors increasingly turned to floating rate senior secured loans ahead of the December interest rate hike.3
OPEC and its allies
Energy credit responded favorably to an agreement among non-OPEC producers to scale back their output by 558,000 barrels a day.5 High yield energy bonds and senior secured energy loans rose approximately 0.46% and 2.36%, respectively, in the week ended December 15 and remain one of the best performing corporate credit sectors of 2016.6,7 Together with the 1.2 million barrel-a-day cut agreed to by OPEC in November, the total reduction represents almost 2% of the global oil supply. In its monthly oil report, the International Energy Agency said the oil market could fall into deficit in the first half of 2017 if the oil producers stick to their production target.8 Year to date, high yield energy bonds are providing returns of approximately 37.9% after returning -23.6% and -7.4%, respectively, in 2015 and 2014.6 Year to date, energy loans are providing returns of approximately 36.9% after returning -27.2% and -8.9%, respectively, in 2015 and 2014.7
In the long run
As expected, the Fed raised short-term interest rates to between 0.5% and 0.75% on Wednesday.9 With this week’s 25 basis point rate hike already priced into the market, investors immediately turned their attention to the Fed’s latest economic projections and a new “dot plot” for fresh clues about the future pace of interest rate increases.10 Explaining its decision to raise short-term interest rates for only the second time since 2006, the Fed said that the increase came “in view of realized and expected labor market conditions and inflation” and judged that the “near-term risks to the economic outlook appear roughly balanced.”9 With the rate hike largely a foregone conclusion, investors were surprised by a slight shift in rate forecasts, with Fed officials now expecting three rate hikes in 2017, up from two in September.10 While slightly more hawkish than expected, the Fed continues to expect only “gradual” rate increases and that the fed funds rate will “remain, for some time, below levels that are expected to prevail in the longer run.”9 Despite an uptick in near-term interest rate expectations, the Fed’s long-run projections rose only slightly and, at 3.0%, remains well below the 3.5% Fed officials were forecasting a year ago.10
Chart of the week: Still low for the long run
- In what was a highly telegraphed move, the FOMC on Wednesday raised the federal funds target rate by 25 basis points to 0.5%–0.75%.9 In the press conference following the Fed’s decision, Fed Chair Janet Yellen noted that “the economy has proven to be remarkably resilient” and that the decision to raise the fed funds rate was “a vote of confidence in the economy.”11
- In recent weeks, for example, the unemployment rate in the U.S. dropped to its lowest level since August 2007, while the service sector of the U.S. economy reported a strong expansion in November.12,13 At the same time, consumer sentiment in December, as measured by the University of Michigan, reached its highest point since January 2015.14
- Despite investors’ renewed sense of optimism, the Federal Reserve continues to forecast that economic growth in the coming years will remain mild – just 1.8% for its longer-run estimate and unchanged from its September forecast.10 Likewise, it forecasts inflation to reach a maximum of just 2.0% through 2019.10
- With this in mind, the FOMC did raise its estimate for the longer-run fed funds rate from that of its September projection – from 2.875% to 3.0%. Yet it remains 50 basis points below where it was just one year ago.10
1 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
2 Bank of America Merrill Lynch High Yield Master II Index.
3 Thomson Reuters Lipper.
4 Credit Suisse Leveraged Loan Index.
5 Reuters, http://reut.rs/2gMrWoo.
6 Bank of America Merrill Lynch High Yield Energy Index.
7 Credit Suisse Leveraged Loan Index (energy component).
8 International Energy Agency, http://bit.ly/2hiRPz1.
9 U.S. Federal Reserve, http://bit.ly/2gJAHDJ.
10 U.S. Federal Reserve, http://bit.ly/2h1fW2h.
11 Federal Reserve, http://bit.ly/2hAz4Vr.
12 Bureau of Labor Statistics, http://bit.ly/L8BKrM.
13 Institute for Supply Management: http://bit.ly/2g2jSi6.
14 University of Michigan Survey of Consumers, http://bit.ly/2hOoe1J.
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