Corporate credit prices pulled back slightly this week as geopolitical tensions weighed on investor appetite. Declining in each of the past seven trading days, high yield bonds are now providing total returns of approximately -0.67% in August, as this week’s equity declines and slight uptick in volatility provided some mild headwinds for the asset class.1 After returning approximately 1.15% in July, high yield bonds are now providing returns of approximately 5.41% in 2017, with CCC rated bonds (7.89%) outperforming BB rated bonds (5.11%).1,2,3 Declining to near a three-year low of 5.40% in late July, high yield bond yields have since widened to 5.74% as commodity price volatility and an increase in new-issue volume have taken some steam out of the recent rally.4,5 Senior secured loans were also modestly lower, returning approximately -0.70% in the week ended August 10 after returning approximately 0.78% in July, the strongest monthly performance so far in 2017.6 Month to date, senior secured loan returns are relatively flat (-0.06%), outperforming high yield bonds (-0.67%) and underperforming investment grade bonds (0.23%) over the same period.1,6,7
Following last week’s nonfarm employment report, the economic calendar was relatively thin, with Friday’s Consumer Price Index (CPI) report the main focus for bond investors.8 Both headline CPI and core CPI rose 0.1% in July, against expectations of 0.2%.9 From a year earlier, core consumer prices rose 1.7%.9 The report marked the latest sign of weakening inflation pressures and rounded out a week of relatively lackluster U.S. economic data. Earlier, the Labor Department said U.S. worker productivity increased at an annual rate of 0.9% in the second quarter, up from a 0.1% growth rate in the first quarter of 2017.10 At 1.2%, year-over-year growth showed a modest pickup in worker productivity.10 However, it remains subdued by historical standards and shows few signs of breaking out of the slow growth that has persisted over the past decade.11
Fed funds futures lower
Benign inflation data and escalating tensions between North Korea and the United States pushed U.S. 10-year Treasury yields out of the relatively tight trading range seen over the past several weeks.12 U.S. 10-year Treasury yields briefly declined below 2.2% this week after drifting between 2.25% and 2.35% over the past four weeks.12 Meanwhile, the two-year Treasury yield slipped to its lowest level since mid-June amid geopolitical uncertainty and growing investor expectations of a slower path of interest rate increases through the remainder of 2017.13 While most economists still expect the U.S. Federal Reserve to begin shrinking its balance sheet in September and raise interest rates in December, investors appear to disagree.14 Fed funds futures currently place odds of a December rate hike at just 32%, down from 50% last week. With inflation remaining elusive for now, each new piece of data is likely to become increasingly significant leading up to the next several FOMC meetings.
Chart of the week: Equities in a tight trading range
- Global markets fell on Thursday as geopolitical tensions flared between the United States and North Korea. Stocks on Thursday faced their largest decline since March and marked the end of what was a historic run of low volatility within the domestic equity markets.
- Major measures of volatility within the equity and fixed income markets have trended lower in 2017, yet recent weeks’ activity put an exclamation point on the broader trend. For example, the S&P 500 Index just completed 15 consecutive days, from July 20 through August 9, in which daily total returns were within 0.3% (either positive or negative).15
- Never before has the U.S. stock market remained within such a tight trading range for such a long time.15 In fact, the S&P 500 Index has not experienced a move of 2% or more in 2017, another rarity this late into a calendar year.15
- Of course, volatility is cyclical and, while it has remained constrained in 2017, it can’t last at such extreme lows, or highs, forever. Since 1990, the long-term average value of the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX Index, is 19.5.16
- As we saw this week, however, any number of events, market or geopolitical, could reverse the years-long trend of declining volatility. It is in market environments like today’s, when equity indexes remain near all-time highs and bond yields near cyclical lows, that investors may consider preparing for volatility to increase once again.
1 Bank of America Merrill Lynch U.S. High Yield Master II Index.
2 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index.
3 Bank of America Merrill Lynch U.S. High Yield BB rated Index.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
5 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
6 Credit Suisse Leveraged Loan Index.
7 Bank of America Merrill Lynch Corporate Master Index.
8 The Wall Street Journal, http://bit.ly/2eP8Dtx.
9 Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
10 Bureau of Labor Statistics, http://bit.ly/2vpSbKZ.
11 Bureau of Labor Statistics, http://bit.ly/2pLGYC1.
12 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
13 Federal Reserve Bank of St. Louis, http://bit.ly/2anGvQ0.
14 The Wall Street Journal, http://on.wsj.com/2vWr4IR.
15 Bloomberg, as of August 11, 2017.
16 Bloomberg, based on the average VIX level from January 1990 through August 10, 2017. The VIX Index measures expected equity volatility.
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.