Steady as she goes
Corporate credit prices were generally stronger, helped by a rise in oil prices, low market volatility and near-record-high stock prices.1,2,3 High yield bonds rose alongside a decline in long-end U.S. Treasury yields, even as U.S. high yield bond mutual funds recorded a fourth straight week of outflows.4,5 A total return of 0.23% for the week ended July 13 pushed high yield bond returns into positive territory for the month of July.6 Year to date, high yield bonds are providing returns of 5.07%, benefiting from a generally benign interest-rate environment and ongoing investor appetite for higher-yielding fixed income investments.6 From a 2017 high of 6.18% in March, high yield bond yields have since tightened to approximately 5.69%.7 For perspective, investment grade bonds currently yield approximately 3.21% and senior secured loans currently yield approximately 6.07%.8,9 Though underperforming high yield bonds through the first half of 2017, senior secured loans are outperforming high yield bonds so far in July. Month to date, the asset class is returning 0.26%, benefiting from a stretch of inflows and a steady rise in LIBOR.10 By comparison, high yield bonds and investment grade bonds are providing returns of 0.15% and 0.04%, respectively.6,11

Modestly dovish
While U.S. Federal Reserve Chair Yellen’s testimony before Congress seemed designed to avoid sending any new signals regarding the central bank’s plans to begin shrinking its balance sheet and the timing of its next rate hike, U.S. Treasury yields declined in reaction to remarks generally viewed as dovish.12 In the context of recent declines in measures of inflation, Yellen reiterated that the Fed still expects inflation to pick up.13 However, she allowed that the Fed is watching the data “very closely” and is prepared to “adjust” its policy if inflation remains stubbornly low. She further stated that “considerable uncertainty always attends the economic outlook. There is, for example, uncertainty about when – and how much – inflation will respond to tightening resource utilization.”13 While doing little to shift investor expectations away from a September start to begin balance sheet normalization and a December rate hike, Yellen’s remarks refocused attention on last week’s disappointing wage growth figures and put increased importance on Friday’s U.S. Consumer Price Index (CPI) report.14

Inflation uncertainty
U.S. Treasury yields declined across the curve Friday morning following economic data that reinforced recent softness in inflation. Reflecting lower gasoline, new vehicle and airfare prices, headline CPI rose 0.1% in June and just 1.6% over the past 12 months, slowing from 1.9% in May.15 Core CPI also rose 0.1% in June, against expectations of a rise of 0.2%.15 The report is the latest in a string showing inflation on the decline and the last before the Fed’s July 25–26 meeting. Recent communication from Fed officials indicates they view any weakness in inflation to be transitory, with Yellen saying this week that “it’s premature to reach the judgment that we’re not on the path to 2% inflation over the next couple of years.”16 Nevertheless, following this week’s disappointing CPI figures and weaker-than-expected U.S. retail sales, bond investors signaled their doubts that inflation will rise by pushing long-end Treasury yields lower and reducing their expectation of another interest rate hike before year end.17 As of Friday morning, the yield differential between the 10-year U.S. Treasury note and the 30-year Treasury bond was sitting at an 8.5-year low and the odds of a rate hike in December had slipped below 50%.18,19

Chart of the week: LIBOR climbing higher

  • After more than 6 years anchored at very low levels, three-month LIBOR, or the London Interbank Offered Rate, quietly breached the 1% mark in early January 2017. Since then, LIBOR has continued to rise along with short-term U.S. Treasury rates.17 For example, the 2-year U.S. Treasury note has risen nearly 20 basis points year to date, while LIBOR reached approximately 1.3% this week.17
  • LIBOR is one of the most widely used benchmarks for short-term interest rates and reflects the average estimated rate at which banks borrow from one another to fund short-term cash needs.
  • LIBOR’s persistent climb in 2017 is important because it’s tied to trillions of dollars of consumer and commercial loans, including the senior secured loan market.
  • Virtually the entire senior secured loan market features LIBOR floors, which set a minimum rate of yield should LIBOR drop below a stated level, of 1% or lower.20 With LIBOR’s protracted appreciation, the coupons of potentially billions of dollars of senior secured loans should begin, or continue, to reset at higher rates in the coming months.

1 Federal Reserve Bank of St. Louis,
2 Federal Reserve Bank of St. Louis,
3 Federal Reserve Bank of St. Louis,
4 Federal Reserve Bank of St. Louis,
5 Thomson Reuters Lipper.
6 Bank of America Merrill Lynch U.S. High Yield Master II Index.
7 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
8 Bank of America Merrill Lynch U.S. Corporate Master Index (yield-to-worst).
9 Credit Suisse Leveraged Loan Index (yield to a three-year maturity).
10 Credit Suisse Leveraged Loan Index.
11 Bank of America Merrill Lynch U.S. Corporate Master Index.
12 Federal Reserve Bank of St. Louis,
13 U.S. Federal Reserve,
14 U.S. Department of Labor,
15 U.S. Department of Labor,
16 CNBC,  
17 U.S. Department of Commerce,
18 U.S. Department of Treasury,  
19 Bloomberg, based on CME data.
20 J.P. Morgan High Yield and Leveraged Loan Morning Intelligence, December 1, 2016.

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