Against the backdrop of rising U.S. government bond prices, declining U.S. stocks and an uptick in broad market volatility, corporate credit remained relatively steady this week.1,2 High yield bonds gained on the week even as the CBOE Volatility Index rose the most since the U.K.’s referendum to leave the European Union.3 Despite the setback for stocks, high yield bonds eked out a small gain during the week ended May 18 as rising oil prices and a benign interest rate environment helped to boost investor appetite.4 U.S. high yield bond mutual funds recorded an inflow of approximately $650 million for the week ended May 17, snapping two consecutive weeks of outflows totaling $2.1 billion over that span.5 Energy high yield bonds outperformed the broader benchmark as oil prices gained ahead of next week’s OPEC meeting, where production cuts are widely expected to be extended.6 Energy high yield bonds returned 0.17% during the week ended May 18 and are now providing a year-to-date gain of approximately 3.1%.7
Senior secured loans were largely unaffected by this week’s steep decline in U.S. stocks and significant decline in U.S. Treasury yields, returning approximately 0.10% during the week ended May 18.8 Year to date, senior secured loans are providing returns of approximately 1.85% amid steady investor demand for low-duration investments, whose values are less affected by a change in interest rates.8 Following a 27th consecutive weekly inflow, bank loan mutual funds have now recorded inflows of $21.6 billion since November 16.5 Amid significant demand for the asset class, senior secured loan yields have continued to tighten, with average yields now sitting at approximately 6.0%, down from 6.3% at the outset of 2017.9 For perspective, high yield bonds and investment-grade bonds currently yield approximately 5.7% and 3.2%, respectively.10,11
U.S. Treasury prices saw their largest one-day price rally in a year this week as political concerns injected a fresh layer of uncertainty surrounding the timing and details of large fiscal stimulus.2 A handful of headlines, including a report that President Trump disclosed intelligence to a Russian foreign minister, redirected attention away from tax reform and other stimulus measures.12 The U.S. dollar fell and the U.S. government bond yields flattened across the curve, unwinding almost all the gains since November’s U.S. presidential election.13,14 The move upended weeks of stability, causing investors to briefly dial back their expectations for interest rate increases through the remainder of 2017. Fed fund futures now suggest investors see a 98% chance of an interest rate hike at the FOMC’s next meeting in June.15 However, confidence in a subsequent rate hike has declined, with investors seeing only a 38% chance of a rate hike during the second half of 2017.15 While this week’s U.S. jobless claims suggest a further tightening of the labor market, there are fresh signs that inflation is easing.16 Following last week’s unexpectedly weak consumer price index and modest retail sales figures, St. Louis Federal Reserve President Bullard noted this week that the U.S. Fed’s current projected path for raising rates may be “overly aggressive.”17,18,19
Chart of the week: Yield curve flattens
- U.S. government bonds pulled back this week as U.S. political concerns drove investors toward safe-haven investments. The U.S. 10-year yield declined to 2.2%, the lowest level since late April and the largest one-day decline since the U.K.’s decision to leave the European Union last June.2
- The yield premium between the 10-year Treasury note and the two-year note fell to 0.98% – the lowest level since late October immediately preceding the U.S. presidential election. A declining premium is known as a flattening yield curve and usually indicates a reduced outlook for U.S. economic growth and inflation.
- The move came in a week that saw U.S. stocks pull back and the CBOE Volatility Index spike amid growing concerns over the Trump administration’s ability to deliver on tax reform and other pro-growth initiatives.3
- While investors appear to still be pricing in a rate hike in June and modestly higher growth and inflation expectations over the short term, their longer-term expectations appear to be fading. As indicated by the flattest yield curve in over six months, bond investors still do not anticipate faster economic growth or a significant uptick in inflation over the long run.
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
3 Federal Reserve Bank of St. Louis, http://bit.ly/295DSwP.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Thomson Reuters Lipper.
6 The Wall Street Journal, http://on.wsj.com/2qFfwUM.
7 Bank of America Merrill Lynch U.S. High Yield Energy Index.
8 Credit Suisse Leveraged Loan Index.
9 Credit Suisse Leveraged Loan Index (based on a three-year maturity).
10 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
11 Bank of America Merrill Lynch U.S. Corporate Master Index (yield-to-worst).
12 The Washington Post, http://wapo.st/2q0RcvF.
13 Federal Reserve Bank of St. Louis, http://bit.ly/2dn26Gw.
14 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
15 Bloomberg, based on CME data.
16 U.S. Department of Labor, http://bit.ly/298eR69.
17 U.S. Department of Labor, http://bit.ly/2jKLr2f.
18 U.S. Census Bureau, http://bit.ly/Y4FaTF.
19 Reuters, http://reut.rs/2rlR1iv.
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