Corporate credit was flat to slightly weaker in the shortened holiday week as the rally in U.S. equities faded and oil prices saw some increased volatility.1 High yield bond prices were modestly lower as U.S. Treasury yields rose and the asset class saw its first weekly outflow in four weeks.2 Senior secured loans were relatively flat as bank loan mutual funds recorded their 24th weekly inflow of the past 25 weeks and LIBOR continued to drift higher.3,4 Year to date, high yield bonds are providing returns of approximately 1.0% as the asset class benefited from expectations of rising corporate earnings and the ongoing rebound in energy credit.5 Senior secured loans have gained 0.47% to begin 2017, after providing returns of 9.88% in 2016, with energy senior secured loans and CCC rated loans continuing to outperform the broader benchmark.6 Year to date, energy senior secured loans have gained approximately 3.46% and CCC rated loans have returned 2.23% as investors continue to seek out corners of the market that offer incremental yield.7,8
OPEC production cuts
Oil prices saw additional volatility this week, declining to begin the week on a stronger U.S. dollar before rising again on expectations that decreasing OPEC production will help to bring global supply and demand back into balance.9 Once again, investors largely looked past a further build in U.S. oil inventories to focus on output cuts by OPEC and its allies.10 In its latest monthly report, the International Energy Agency said OPEC production fell by 320,000 barrels a day in December and raised its 2016 oil demand growth outlook by 100,000 barrels per day.11 The report, however, also raised the possibility of a rebound in U.S. output, as higher oil prices support an increase in shale production.10 Against the backdrop of some short-term oil price volatility, energy credit continued to benefit from the longer-term trend of rising prices and an overall improvement in energy company balance sheets.12 From a high of 21.0% in February 2016, high yield bond yields have since tightened to 6.1%.13 By comparison, energy senior secured loan yields have tightened from 26.1% to 12.4% over the same period.14
Most of the U.S. economic data released this week appeared supportive of additional moves by the U.S. Federal Reserve to raise rates this year. The Consumer Price Index (CPI) rose 2.1% from the year before in December, the largest year-over-year increase since June 2014, while the core CPI rose 2.2%.15 Meanwhile, industrial production climbed 0.8% in December, the largest percentage rate since November 2014.16 Notably, capacity utilization rose to 75.5%, indicating a modest pickup in factory activity.16 While investors are still looking for more clarity around President Trump’s priorities and policy details, in comments this week U.S. Fed Chair Janet Yellen said the economy was closer to achieving its labor-market and inflation goals, but long-term challenges to growth remained.17 Yellen emphasized that slow labor force and productivity growth are likely to “continue to restrain overall growth” and that the future path of interest rates “will depend on many different factors, of which fiscal policy is just one.”17
Chart of the week: Inflation is emerging
- After several years in which investors around the world feared inflation was too low, a reflationary environment seems to be emerging once again. Data released this week showed that inflation in the United States, as measured by the Consumer Price Index (CPI), climbed just above the Fed’s target inflation rate of 2.0% in December.15
- Both headline CPI and core CPI, which strips out volatile food and energy prices, came in above the 2.0% mark.15 Rising prices for energy, rent and medical servcies were the main contributors over the year to the headline number.15
- On Wednesday, the U.S. dollar reversed a Tuesday slide as investors digested the inflation data along with Yellen’s note in a San Francisco speech that “the economy is near maximum employment and inflation is moving toward our goal.”18
- While investors appear to be preparing for a more active Federal Reserve in 2017 and beyond, it should be noted that the Personal Consumption Expenditures (PCE) Index, which is the Fed’s preferred measure of inflation, has been on the rise, but remains well below 2.0%.19
- Further, Yellen also highlighted in her speech her view that it makes sense to “gradually reduce the level of monetary policy support” to the economy. Should the FOMC follow through on its own forecasts for 2017, the median projection for the target federal funds rate still rests at just 1.4%.20
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
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/2dn3Kt7.
5 Bank of America Merrill Lynch U.S. High Yield Master II Index.
6 Credit Suisse Leveraged Loan Index.
7 Credit Suisse Leveraged Loan Index (Energy Component).
8 Credit Suisse Leveraged Loan Index (CCC Component).
9 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
10 U.S. Energy Information Administration, http://bit.ly/1Fke1JG.
11 International Energy Agency, http://bit.ly/1ylJ2td.
12 The Financial Times, http://on.ft.com/2jHAba1.
13 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
14 Credit Suisse Leveraged Loan Index (Energy Component based on a three-year maturity).
15 Bureau of Labor Statistics, http://bit.ly/2jCsp14.
16 U.S. Federal Reserve, http://bit.ly/2jHAb9Q.
17 U.S. Federal Reserve, http://bit.ly/2j09HiH.
18 Federal Reserve, http://bit.ly/2jMGwOp.
20 Federal Reserve, http://bit.ly/2h1fW2h.
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