Corporate credit: modestly positive
Corporate credit prices were stable to modestly higher this week amid persistently low levels of market volatility and a flattening U.S. Treasury yield curve.1,2 High yield bond returns were mildly positive as the 10-year U.S. Treasury yield touched its lowest level of 2017 and the asset class recorded its third straight weekly inflow.3,4 Month to date, high yield bonds are providing returns of approximately 0.23% as the benefits of accelerating declines in U.S. Treasury yields have continued to outweigh any pressure on oil prices.5,6 High yield bond mutual funds have now posted net inflows of approximately $1.3 billion since the week ended May 24, enough to erase just a portion of the nearly $8 billion in net outflows the asset class has sustained thus far in 2017.4 Nevertheless, high yield bonds are generating solid year-to-date returns of more than 5.0% and are currently on track for their third straight month of positive returns.5 High yield bond yields have widened slightly from recent lows and are now sitting at 5.51%, up from a low of 5.45% two weeks ago, but down from a 2017 high of 6.19%.7 Despite moderating in recent weeks, inflows into bank loan mutual funds persisted during the week ended June 14, with the asset class reporting inflows in 44 of the past 46 weeks for a total of $26.1 billion over that span.4 Year to date, senior secured loans are now providing returns of approximately 2.0%, with energy senior secured loans outperforming the broader benchmark.8,9
Interest rate rise
The U.S. Federal Reserve delivered largely as expected this week by raising short-term interest rates by 25 basis points, leaving its economic and interest rate forecasts mostly unchanged and providing more clarity around plans for balance sheet normalization.10 Noting that inflation “is expected to remain somewhat below 2 percent in the near term,” the Fed gave a nod to the recent soft inflation data.10 However, if investors were looking for signs that the Fed would stand pat for the remainder of the year, they were hard to find in the remainder of the statement or in Fed Chair Yellen’s post-meeting press conference.11,12 Over the longer run, the Fed continues to see inflation rising back to its 2% objective and introduced a plan to begin reducing its $4.5 trillion balance sheet “relatively soon.”,13,14 The takeaway seemed slightly more hawkish than some economists had expected, with an earlier-than-expected start to balance sheet normalization perhaps pushing the next rate hike to December, but by no means taking it off the table for the remainder of 2017.14
Yields: the world is flat
In light of the Fed’s refusal to back away from normalization plans, yields on short-dated U.S. Treasury notes rose during the week as the overall yield curve flattened further.2 Still, bond investors continue to price in a lower trajectory of rate hikes than the path predicted by the Fed. As of Friday, Fed funds futures were suggesting investors now see only a 34% chance of an additional rate hike through the remainder of 2017.15 U.S. economic data continues to suggest inflation pressures remain muted, with consumer price data, U.S. retail sales, the University of Michigan consumer sentiment index and housing starts all disappointing to the downside this week.16,17,18,19 U.S. government bond prices rallied early in the week after the consumer price index (CPI) unexpectedly declined and retail sales recorded their largest drop in 16 months, with the U.S. 10-year Treasury yield briefly declining to its lowest level of the year.16 Following another disappointment from consumer sentiment data and a decline in new home permits, the yield curve has now flattened a cumulative 39 basis points since the March 14 Fed rate hike and over 50 basis points since late December.2,18,19
Chart of the week: Inflation expectations still moderating
- As expected, the Federal Reserve continued its slow path toward normalizing interest rates this week, raising the target federal funds rate to a range of 1%–1.25%.11 Along with Wednesday’s rate hike, policy makers made very few changes from the March meeting to their Summary of Economic Projections. They affirmed their plan to raise interest rates for a total of three times in 2017.11
- At the accompanying press conference, Chair Yellen brushed off recent softness in inflation data, referring to lower readings as having been “driven significantly by what appear to be one-off reductions” in certain prices.20
- While members of the Fed remain confident that recent economic weakness is likely “transitory,” markets seem less certain.21 Yields on 10-year Treasury notes have declined fairly steadily since March.
- The market-implied probability of the FOMC enacting three rate hikes in 2017 dropped below 50% this week.15 Additionally, 5- and 10-year breakeven inflation rates, which measure market-implied inflation expectations, dropped sharply this week, furthering a trend that began in late January 2017.22
1 Federal Reserve Bank of St. Louis, http://bit.ly/295DSwP.
2 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
3 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
4 Thomson Reuters Lipper.
5 Bank of America Merrill Lynch High Yield Master II Index.
6 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
7 Bank of America Merrill Lynch High Yield Master II Index (yield-to-worst).
8 Credit Suisse Leveraged Loan Index.
9 Credit Suisse Leveraged Loan Index (energy component).
10 U.S. Federal Reserve, http://bit.ly/2rwAKDv.
11 U.S. Federal Reserve, http://bit.ly/2rhINV5.
12 CNBC, http://cnb.cx/2rwSwq1.
13 U.S. Federal Reserve, http://bit.ly/2tn18Rp.
14 The Wall Street Journal, http://on.wsj.com/2rE4JJF.
15 Bloomberg, based on CME data.
16 U.S. Department of Labor, http://bit.ly/2k22igk.
17 U.S. Department of Commerce, http://bit.ly/Y4FaTF.
18 University of Michigan, http://bit.ly/1gDEQwe.
19 U.S. Department of Commerce, http://bit.ly/1pRnqsp.
20 U.S. Federal Reserve, http://bit.ly/2sx779K.
21 U.S. Federal Reserve, http://bit.ly/2qGwxBe.
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