The corporate credit markets were generally stronger this week amid a pullback in U.S. government bond yields, rising oil prices and some weaker-than-expected economic data.1 High yield bond prices recouped some of their March declines, returning approximately 0.21% during the week ended April 7, as high yield bond mutual funds recorded the largest weekly inflow in three months.2 Following $7.3 billion in investor withdrawals last month, flows for high yield bond funds reversed course and posted $2.4 billion in inflows for the week ended April 5.3 High yield energy bonds were an outperformer, returning 0.59% this week as oil prices rose to a one-month high.4,5 This more than makes up for the 0.40% decline high yield energy bonds sustained in March, which was the largest setback for the sector in 13 months.5 Senior secured loans also benefited from ongoing demand, returning 0.15% this week after returning 0.08% in March.6 For context, senior secured loans were among the best performing fixed income asset classes in March, outperforming high yield bonds (-0.40%), investment grade corporate bonds (-0.12%), U.S. 10-year Treasuries (-0.13%), and U.S. 30-year Treasuries (-0.69%).2,7,8,9
Middle market premium
During the first quarter, issuance of U.S. high yield bond and senior secured loans surged to $86 billion and $345 billion, respectively, as borrowers took advantage of strong market conditions to issue corporate debt.10 The rise in corporate issuance was driven primarily by refinancing activity – which represented approximately 76% of the volume in the senior secured loan market – as more companies sought to lower the interest rates they pay on corporate loans.10 Partly as a result of this jump in refinancing activity, yields across the corporate credit market continued to tighten throughout the first quarter of 2017. For example, yields on newly issued, broadly syndicated senior secured loans tightened by approximately 0.40%, from approximately 4.9% to 4.5%.10 By comparison, the decline was somewhat less pronounced within the middle market space. There, yields on newly issued middle market loans declined by 0.26%, from less than 6.4% to approximately 6.1%.10 Because they are smaller and generally have fewer places to turn for their capital needs, middle market companies often pay a higher rate of interest compared to their larger peers. For perspective, this so-called “middle market premium” has averaged approximately 1.20% over the past seven years, or approximately 0.40% below current levels.10
Weather or not
U.S. 10-year Treasury note yields briefly fell to their lowest level since November on Friday following what was generally viewed as a disappointing nonfarm payrolls report.1 At 98,000, jobs growth in March came in well below consensus expectations of 175,000.11 Meanwhile, average hourly earnings rose a modest 0.2% month over month and 2.7% year over year.11 While weaker than expected, the March report may have been impacted by weather effects and may suggest the U.S. economy is nearing full employment.12 Despite the slowdown in payroll gains, the unemployment rate dropped to 4.5%, the lowest in almost a decade.11 While the jobs report was this week’s key data point, investors also zeroed in on minutes from the March FOMC meeting.13 U.S. Federal Reserve officials agreed at their March meeting that they would likely begin shrinking its $4.5 trillion portfolio “later this year” and anticipated “gradual increases” in interest rates.13 Although any discussion of a reduction of the Fed’s balance sheet was viewed as somewhat hawkish, U.S. government bond yields ended the week lower, with the U.S. yield curve now at its flattest since last October.14
Chart of the week: Inflation reaching a plateau?
- Minutes from the March FOMC meeting revealed that the Fed is currently engaged in a healthy debate about inflation. According to the minutes, some members thought that recent gains in inflation “should not be overstated,” while others “commented that recent inflation data were stronger than they had expected.”15
- Indeed, inflation has recently been moving up from its extraordinarily low point of recent years. The Consumer Price Index reached 2.7% in February 2017 while Personal Consumption Expenditures, the Fed’s preferred measure of inflation, has been climbing steadily since July 2016.16,17 It reached 2.1% in February 2017.17
- While the upward trends have caught many investors’ attention, markets have taken the moves in stride. The U.S. Treasury yield curve, for example, has flattened slightly over the past month.18
- Meanwhile, the market is betting on inflation remaining relatively tame over the coming 12 months. As the chart highlights, the probability that inflation will fall within a range of 1.5% to 2.5% in the next 12 months has climbed to its highest point since the global financial crisis.19
- This is generally in line with a November 2016 assertion from a Cleveland Fed commentary, which looked at six models that have historically performed well at forecasting inflation. Five of the six models suggested that inflation was likely to remain at 2.0% or below through the next three years.
1 Federal Reserve Bank of St. Louis, http://bit.ly/1fKNCzo.
2 Bank of America Merrill Lynch High Yield Master II Index.
3 Thomson Reuters Lipper.
4 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
5 Bank of America Merrill Lynch High Yield Energy Index.
6 Credit Suisse Leveraged Loan Index.
7 Bank of America Merrill Lynch Corporate Master Index.
8 Bank of America Merrill Lynch 10-year U.S. Treasury Index.
9 Bank of America Merrill Lynch 30-year U.S. Treasury Index.
10 Thomson Reuters LPC, Leveraged Loan Monthly, March 2017, http://tmsnrt.rs/2nLGNCh.
11 U.S. Department of Labor, http://bit.ly/2iYbHWM.
12 Bloomberg, https://bloom.bg/2oIIBk2.
13 U.S. Federal Reserve, http://bit.ly/2nGwU8U.
14 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
15 Federal Reserve, http://bit.ly/2nGwU8U.
16 U.S. Bureau of Labor Statistics, http://bit.ly/2oFx8Sp.
17 U.S. Bureau of Labor Statistics, http://bit.ly/1cR0IcA.
19 Federal Reserve Bank of St. Louis, http://bit.ly/2nICA2b.
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