Corporate credit turned higher following Wednesday’s U.S. Federal Reserve rate hike, recovering from some earlier weakness as U.S. Treasury prices rallied and U.S. equities rose.1 Though climbing during the week ended March 16, high yield bond returns remain negative in March amid a pivot in the Fed narrative, rising Treasury yields and ongoing outflows from high yield bond mutual funds.2 Month to date, high yield bonds are on pace for their first negative monthly return since November.2 In the largest weekly outflow since August 2014, high yield bond mutual funds recorded an outflow of $5.7 billion for the week ended March 15.3 Notably, the majority of this week’s outflows took place before the conclusion of this week’s Federal Open Market Committee meeting and the release of its somewhat dovish policy statement.4 Senior secured loans have remained mostly stable in March, benefiting from rising prospects of a near-term rate hike, higher LIBOR rates and ongoing inflows into the asset class from investors looking for assets whose values are less impacted by a change in interest rates.5 Bank loan mutual funds recorded an inflow of $863 million for the week ended March 15, marking their 18th consecutive weekly inflow for a total of more than $18 billion over that span.3 Month to date, senior secured loans are generating returns of approximately 0.14%, outperforming high yield bonds (-0.91%), investment-grade corporate bonds (-1.04%), U.S. 2-year Treasuries (-0.16%) and U.S. 10-year Treasuries (-1.35%).2,5,6,7,8
As expected, the Fed raised its benchmark a quarter point and continued to project two more increases through the remainder of 2017.4 Given that the hike was so strongly telegraphed, investors were more focused on the FOMC’s economic projections and the tone struck during Chair Yellen’s post-meeting press conference.9 For now, the central bank stuck with its “gradual” approach to tightening monetary policy, while leaving its forecasts largely unchanged.10 Fed officials continue to project three quarter-percentage point increases in 2018, suggesting they don’t foresee a large pickup in inflation, and expect rates to settle at their long-term average of 3% by the end of 2019.10 They also left unchanged their 2017 economic growth projections and continue to expect growth of 1.8% over the longer run.10
By leaving its economic and interest projections little changed, the Fed seemed to be in no more of a hurry to tighten monetary policy in March than it was in December.11 Despite the sharp shift in communications leading up to this week’s rate hike, the overall message appeared to be of a Fed that has not deviated substantively from the gradualist message it was communicating at the outset of the year. Though rising ahead of the release of the FOMC’s March statement, U.S. Treasury yields declined across the curve after the Fed signaled an ongoing cautious approach. Rising to a year-to-date high of 2.6% on Tuesday, the yield on the 10-year U.S. Treasury note had slipped below 2.5% by week’s end as the Fed’s gradualist message resonated.12 In her post-meeting press conference, Yellen reiterated the belief that the longer-run neutral rate is likely to remain low by historical standards due to structural changes taking place around the world: “I think, in part, it reflects slowing population growth, and also slow productivity growth here and in many other advanced nations.”13
Chart of the week: Virtually unchanged
- As expected, the FOMC raised the federal funds target range this week by 25 basis points, to 0.75%–1.00%.4 Despite making the policy move, the FOMC’s own economic projections continued to paint a picture of an economy that should experience slow economic growth and low interest rates well into the future.
- For example, the FOMC’s longer-run projection for GDP growth remained grounded at just 1.8%.10 Personal consumption expenditure (PCE) inflation expectations stayed at the Fed’s goal of 2.0%, while the Fed’s expectations for the longer-run federal funds target rate held steady at just 3.0%, well below the historical average at this point in a recovery.10,14
- The only change to the Fed’s longer-run projections from its December meeting came from the unemployment rate, which was lowered modestly from 4.8% to 4.7%.10
- As noted in both the statement and press conference accompanying the FOMC’s policy move, the Fed expects to be gradual in its efforts to normalize interest rates. With long-term interest rates expected to remain low by historical standards, investors could continue to face difficulties finding income through the coming years.
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Bank of America Merrill Lynch High Yield Master II Index.
3 Thomson Reuters Lipper.
4 U.S. Federal Reserve, http://bit.ly/2nobFgj.
5 Credit Suisse Leveraged Loan Index.
6 Bank of America Merrill Lynch Corporate Master Index.
7 Bank of America Merrill Lynch U.S. 2-Year Treasury Index.
8 Bank of America Merrill Lynch U.S. 10-Year Treasury Index.
9 U.S. Federal Reserve, http://bit.ly/2nhhFqu.
10 U.S. Federal Reserve, http://bit.ly/2nFr8ER.
11 U.S. Federal Reserve, http://bit.ly/2h1fW2h.
12 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
13 U.S. Federal Reserve, http://bit.ly/2nhhFqu.
14 Federal Reserve, NBER, FS Investments.
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