The corporate credit markets strengthened this week, reflecting rising equities, solid U.S. economic data and sustained risk appetite by investors searching for yield.1 High yield bond prices rose throughout the week, adding to the gains already achieved in 2017. Year to date, high yield bonds are now providing returns of approximately 2.1% as investors continue to seek out investments whose values are less affected by a rise in interest rates.2 As high yield bond prices have rallied, yields continue to decline, tightening to approximately 5.7% this week.3 For perspective, that is down from 10.1% just a year ago when declining oil prices and increased global economic concerns were sapping demand at the lower end of the ratings spectrum.3 Senior secured loan prices also ticked higher throughout the week, as bank loan mutual funds recorded yet another weekly inflow. This week’s $876 million in inflows marked the 14th consecutive weekly inflow since mid-November, for a total of $14.3 billion in inflows over that span.4 Senior secured loans are now providing returns of 0.75% in 2017.5 This follows the 9.9% the asset class generated in 2016.5
Ahead of U.S. Federal Reserve Chair Yellen’s semi-annual congressional testimony, investors were on the lookout for any signals about whether the Fed might raise rates at its next policy meeting on March 14–15. Given that the market was pricing in just a 28% chance of a March rate hike before the testimony, it likely would have been difficult for her to sound more dovish on rates than the market was expecting.6 In the end, investors appeared to zero in on comments that, on the surface, appeared somewhat more hawkish than markets were expecting. She reported that the FOMC sees the economy at, or close to, full employment and that it expects the economic outlook will warrant “further gradual increases.”7 She also said that “waiting too long to remove accommodation would be unwise.”7 While Yellen’s testimony appeared to leave the door open for a rate increase at next month’s meeting, any potential near-term rate hike should be considered against the experience of the last increase. Recall that the Fed had forecast four rate hikes in 2016 and ended up delivering only one in December, and by that time had been widely telegraphing the move for months in advance.8
A little less unlikely
Yellen’s testimony dovetailed with some solid U.S. economic releases this week, which pointed to a generally improved outlook for inflation. Strong U.S. retail sales combined with rising producer and consumer prices boosted investor confidence in ongoing U.S. growth.9 Producer prices rose strongly in January, with headline PPI rising 0.6% month over month.10 Meanwhile, headline consumer prices increased 0.6% in January from a month earlier, while core CPI increased 0.3%.11 CPI rose 2.5% for the 12 months ended January 2017, the largest 12-month increase since March 2012.11 The strong inflation data, combined with the slightly less dovish comments from Fed Chair Yellen, led to increased expectations of tighter monetary policy ahead. U.S. government bond yields rose across the curve, with the yield on the two-year and five-year Treasury notes both briefly rising near a two-month high before slipping again toward week’s end.12,13 Nevertheless, investors still assign a relatively low probability to a rate increase in March. On Friday, the market-implied probability of a rate hike at the Fed’s next meeting was just 32%.6 This compares to a market-implied probability of 96% in the weeks leading up to the Fed’s last rate hike in December 2016.6
Chart of the week: Competitive follow-up performances
- Following a challenging 2015, high yield bonds enjoyed a healthy bounce back in 2016, generating returns of approximately 17.5%.2
- On the heels of such a strong total return, it is important to note that high yield bonds have, at times, turned in solid encore performances in the calendar year immediately after they generated double-digit total returns.
- High yield bonds have returned 10% or more in 14 of the 30 years since the Bank of America Merrill Lynch U.S. High Yield Master II Index’s inception in 1986.2 In four cases, they generated double-digit returns for two or more consecutive years.2
- Returns on high yield bonds have varied greatly in the year following a double-digit return, from approximately 2.3% to 17.4%. Yet their average total return the first year after a 10%-plus return is approximately 9.5%.2
1 The Wall Street Journal, http://on.wsj.com/2lem7F5.
2 Bank of America Merrill Lynch U.S. High Yield Master II Index.
3 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
4 Thomson Reuters Lipper.
5 Credit Suisse Leveraged Loan Index.
6 Bloomberg, based on CME data.
7 U.S. Federal Reserve, http://bit.ly/2lrxz0b.
8 MarketWatch, http://on.mktw.net/200dudd.
9 U.S. Department of Commerce, http://bit.ly/L7q3Tc.
10 U.S. Department of Labor, http://bit.ly/2jfizlj.
11 U.S. Department of Labor, http://bit.ly/2jKLr2f.
12 Federal Reserve Bank of St. Louis, http://bit.ly/2anGvQ0.
13 Federal Reserve Bank of St. Louis, http://bit.ly/2kxkdAr.
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.