Corporate credit rose alongside U.S. equities, oil and Treasury prices.1,2,3 High yield bond prices strengthened in a rally that began with last week’s testimony from U.S. Fed chair Janet Yellen and continued after June’s Consumer Price Index (CPI) report dispelled any inflation concerns.4,5 Against the backdrop of record-high stock prices and declining long-end Treasury yields, high yield bonds returned 0.8% during the week ended July 20, retracing all of the declines experienced between mid-June and early July.6 Amid ongoing demand for yield, bond yields continued to tighten. For example, yields on high yield bonds have declined 24 basis points through the first three weeks of July and are currently sitting at a 36-month low of approximately 5.4%.7 High yield bond mutual funds saw inflows of $2.2 billion this week, the largest weekly inflow since April 2017, snapping a run of four straight weeks of outflows.8 While inflows into bank loan mutual funds have slowed in recent weeks, senior secured loan prices increased as investors have continued to seek out higher yielding investments.8,9 Yields on senior secured loan yields have declined by approximately 17 basis points since the beginning of July and are approximately 6.0% today.10 Month-to-date, senior secured loans are providing returns of approximately 0.5%.9
With oil prices briefly rising to a seven-week high, energy credit was in focus this week.2 On Wednesday, the U.S. Energy Information Administration said U.S. stockpiles fell by 4.7 million barrels during the week ended July 14, the third straight weekly decline and the 13th decline over the past 15 weeks.11,12 After returning -2.1% and -3.2% in June, high yield energy bonds and energy senior secured loans are now providing returns of approximately 2.6% and 2.8%, respectively, in 2017.13,14 Month-to-date, high yield bonds are now providing returns of approximately 0.9%, with returns of 1.6% on high yield energy bonds and 1.9% on CCC rated bonds outperforming the broader benchmark.6,13,15 Energy senior secured loans have underperformed over the past month but outperformed the benchmark index over the past week.9,14
Where’s the inflation?
Following last week’s U.S. Federal Reserve rhetoric in which Chair Yellen allowed that the Fed would closely monitor inflation data and potentially adjust course if necessary, monetary policy was again in focus this week. In particular, investors watched Thursday’s European Central Bank (ECB) and Bank of Japan meetings for any signs of a shift toward a reduction in stimulus.16 In contrast to comments made in June by ECB President Mario Draghi that seemed to signal that the ECB could start winding down stimulus, Thursday’s comments were perceived as decidedly more dovish.17 In its statement, the ECB reiterated that it stood ready to increase its bond-buying program should economic conditions worsen and gave a nod to ongoing subdued measures of inflation.18 “The last thing the governing council may want is an unwanted tightening of the financing conditions.”19 Signaling that inflation in the Eurozone isn’t showing signs of picking up, Draghi’s comments helped to send the yield on the U.S. 10-year Treasury note to its lowest close in over three weeks.20 Looking ahead, investors now turn their attention to next week’s FOMC policy meeting for fresh signs about the future path of interest rates and whether the U.S. Federal Reserve continues to believe that the recent weak inflation data are transitory.21
Chart of the week: Volatility hits a low
- Investors have enjoyed an unusual period in recent years in which both major domestic equity and fixed income markets have generated competitive returns while volatility has been low. For example, U.S. equity indexes touched record highs once again this week while credit spreads across both investment grade and high yield bond markets have slowly declined since February 2016.1,22
- The Chicago Board Options Exchange (CBOE) Volatility Index, or VIX Index, which measures expected equity volatility, reached its lowest point in more than 35 years this week.23 As the Index’s 50-day moving average highlights, equity market volatility has been on the decline since approximately March 2016.23
- Volatility within the fixed income markets has also trended lower, and has recently done so more steeply than the equity market. The Merrill Lynch Option Volatility Estimate (MOVE) Index is a yield-curve weighted average of expected volatility within the bond markets. It has been moving lower since April 2015, but has slid sharply this year.23
- While many investors and financial advisors have become accustomed to generating positive returns through relatively placid market environments, history has shown that volatility can spike quickly and for a variety of reasons.
- It is within environments like today’s that investors may consider preparing for potential changes. When volatility rises, it may be beneficial for investors if the assets within their portfolios display low correlations to the broader market and behave differently from each other.
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
3 Federal Reserve Bank of St. Louis, http://bit.ly/29ecFfc.
4 U.S. Federal Reserve, http://bit.ly/2te2sFX.
5 U.S. Department of Labor, http://bit.ly/2k22igk.
6 Bank of America Merrill Lynch High Yield Master II Index.
7 Bank of America Merrill Lynch High Yield Master II Index (yield-to-worst).
8 Thomson Reuters Lipper.
9 Credit Suisse Leveraged Loan Index.
10 Credit Suisse Leveraged Loan Index (yield to a three-year takeout).
11 The U.S. Energy Information Administration, http://bit.ly/1V2gPZQ.
12 The U.S. Energy Information Administration, http://bit.ly/2ueQorn.
13 Bank of America Merrill Lynch High Yield Energy Index.
14 Credit Suisse Leveraged Loan Index (energy component).
15 Bank of America Merrill Lynch CCC Rated & Lower Index.
16 The Wall Street Journal, http://on.wsj.com/2vqpVWr.
17 Bloomberg, https://bloom.bg/2tL5Bx7.
18 The European Central Bank, http://bit.ly/2uMTC6Z.
19 Bloomberg, https://bloom.bg/2vtqe2U.
20 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
21 U.S. Federal Reserve, http://bit.ly/29y0IjN.
22 Bank of America Merrill Lynch U.S. Corporate Master Index; Bank of America Merrill Lynch U.S. High Yield Master II Index.
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