The corporate credit markets continued to trend higher this week, as low equity volatility, solid U.S. economic data and the prospect of fiscal stimulus contributed to rising risk appetite.1 Beginning with high yield bonds, prices moved higher on the back of the largest weekly inflow into high yield bond mutual funds since early January and a slowdown in new issuance due to the extended President’s Day weekend.2 High yield bonds generated another weekly positive return, bringing the year-to-date gain to approximately 2.7%.3 Lower-rated credits continued to outperform the broader benchmark index as investors continue to reach down the ratings spectrum in their ongoing search for yield. After providing returns of 36.5% in 2016, CCC rated bonds have returned nearly 5.3% so far in 2017.4 That compares to less than 2.0% for BB rated bonds and less than 1.2% for investment-grade corporate bonds.5,6 For the week ended February 22, high yield bond mutual funds recorded an inflow of $726 million, the fourth straight weekly inflow for a total of $1.74 billion over that span.7 Amid ongoing demand, high yield bond yields continued to tighten and are now sitting at a 2.5-year low of approximately 5.65%.8
Senior secured loan prices also benefited from lower new issuance and ongoing demand from bank loan mutual funds and collateralized loan obligations (CLOs).9 Bank loan mutual funds recorded an inflow of $853 million in the week ended February.7 This marks the fifteenth consecutive weekly inflow into the asset class for nearly $15.2 billion over that period.7 Senior secured loans continue to benefit from investor expectations around rising interest and LIBOR rates, generating gains of approximately 0.9% so far in 2017.10 Similar to high yield bonds, the higher-yielding areas of the loan market have experienced the largest outperformance.11 Benefiting from commodity price stability, energy senior secured loans are providing a year-to-date return of approximately 6.2%, with yields in the sector tightening from approximately 13.4% to 11.4% over that span.12,13 By comparison, high yield energy bonds have provided year-to-date gains of 2.8% as yields tightened from 6.44% to 5.98%.14,15
Counting the minutes
In economic news, investors were looking to minutes from the Federal Reserve’s January 31-February 1 meeting to provide further clues about the timing of interest-rate increases, the central bank’s plans for its $4.5 trillion balance sheet and its take on the economic consequence of the Trump administration’s plans for tax cuts and spending increases.16 On each of these themes, the minutes provided little new information relative to the latest FOMC policy statement and U.S. Fed Chair Yellen’s recent testimony before Congress.17,18 As before, the Fed signaled confidence that it can raise rates gradually, while noting that a hike might be appropriate “fairly soon.”16 However, the discussion was tempered by comments that indicated little concern about near-term inflation and “heightened uncertainty” around the timing and scope of the Trump administration’s fiscal policies.16 With no clear signal of an imminent rate increase, U.S. Treasury yields declined to a two-week low, with yields on the 10-year note slipping below 2.35%.19 Despite solid U.S. economic data and the prospect of expansive fiscal stimulus, uncertainty around the French elections, and their implication to the Eurozone, have helped to restrain U.S. Treasury yields in recent weeks.20 European bond yields declined this week after polls showed Marine Le Pen extended her lead for the first round of France’s presidential race, with yields on short-term German government bonds declining to record lows.21
Chart of the week: A continued yield premium
- Many income-oriented investors may find themselves in a difficult position today as yields across a spectrum of asset classes have tightened significantly over the past year.
- While credit markets have rallied since February 2016, risk premiums have declined. For example, yields on high yield energy bonds have compressed from nearly 20% in February 2016 to approximately 6% today.14 Likewise, yields across the broader high yield bond market have decreased by approximately 3% in the same time frame.3
- 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
- As the chart highlights, however, senior secured loans and high yield bonds continue to offer investors a yield advantage over investment grade securities. For example, yields on senior secured loans and high yield bonds are currently 6.2% and 5.7%, respectively, compared to just 3.4% for investment grade bonds.22,8,23 Meanwhile, the yield on 10-year Treasuries settled below 2.4% this week.19
1 Federal Reserve Bank of St. Louis, http://bit.ly/295DSwP.
2 S&P Global Market Intelligence, LCD HY Weekly, 2/23/2017.
3 Bank of America Merrill Lynch U.S. High Yield Master II Index.
4 Bank of America Merrill Lynch High Yield CCC and Lower Rated Index.
5 Bank of America Merrill Lynch High Yield BB Rated Index.
6 Bank of America Merrill Lynch Corporate Master Index.
7 Thomson Reuters Lipper.
8 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
9 S&P Global Market Intelligence, LCD Weekly Wrap, 2/23/2017.
10 Credit Suisse Leveraged Loan Index.
11 Credit Suisse Leveraged Loan Index (CCC Component).
12 Credit Suisse Leveraged Loan Index (Energy Component).
13 Credit Suisse Leveraged Loan Index (Energy Component based on a three-year life).
14 Bank of America Merrill Lynch U.S. High Energy Index.
15 Bank of America Merrill Lynch High Energy Index (yield-to-worst).
16 U.S. Federal Reserve, http://bit.ly/2kN5v8o.
17 U.S. Federal Reserve, http://bit.ly/2kWrohs.
18 U.S. Federal Reserve, http://bit.ly/2l4p216.
19 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
20 The Wall Street Journal, http://on.wsj.com/2lRSGJZ.
21 The Financial Times, http://on.ft.com/2lM4mO3.
22 Credit Suisse Leveraged Loan Index (based on a three-year-life).
23 Bank of America Merrill Lynch U.S. Corporate Master Index (yield-to-worst).
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.