Corporate credit prices ticked modestly higher this week as investor concerns around geopolitical tensions appeared to recede and equity volatility subsided.1 High yield bond prices rose slightly despite another large weekly outflow from the asset class, as lower long-term interest rates and a decline in the CBOE Volatility Index helped to support investor sentiment.1,2,3,4 High yield bond mutual funds recorded an outflow of $1 billion for the week ended August 23.3 This follows the $2.2 billion in outflows recorded the week before and brings the month-to-date net outflows to over $3 billion.3 High yield bonds are currently tracking their first monthly decline since March, providing returns of approximately -0.47% so far in August.2 Nevertheless, high yield bonds remain one of the better-performing fixed income investments in 2017, providing gains of approximately 5.62% year to date.2 Senior secured loans drifted higher throughout the week despite heavy new-issue volume, the bulk of which remains geared to refinancing activity.5,6 Senior secured loans are providing a modest month-to-date decline of 0.15%, outperforming high yield bonds thus far in August even as a decline in long-end Treasury yields has created a mild headwind.4,5
Long-term yields lower
Amid a light economic calendar, U.S. government bonds were largely influenced by broad market sentiment.7 Recently this has included tensions with North Korea and ongoing monetary policy expectations in the face of persistent low levels of inflation.8 Still, U.S. Treasuries have largely traded in a narrow range, with the U.S. 10-year Treasury note yield bouncing between 2.13% and 2.38% over the past three months.4 This week, the yield on the 10-year note trended toward the low end of that range as doubts among investors that the U.S. Federal Reserve will raise interest rates for a third time this year weighed on Treasury yields.4 Minutes from the U.S. Fed’s July meeting showed that a growing number of officials are hesitant to raise interest rates if inflation remains subdued.9 Federal funds futures currently place less than a 40% chance of another rate hike before year end, which played some part in pushing the yield on the U.S. 30-year bond briefly to a year-to-date low this week.10,11 Risks to the Treasury market may come next month as the debate around the debt ceiling receives increased focus after Congress returns from recess and when the Fed is expected to begin reducing its balance sheet.12
While U.S. Fed Chair Yellen was not expected to affect monetary policy expectations in her address in Jackson Hole, WY, other Fed officials were busy weighing in on low inflation figures this week.13 Kansas City Fed President Esther George said that, based on recent economic data, she sees an opportunity to raise interest rates again later this year.14 Meanwhile, Dallas Fed President Robert Kaplan took a more cautious approach, advocating for signs of renewed inflation before hiking rates again.14 The difference in rhetoric highlights the division within the central bank over whether recently weak inflation figures are transitory or whether they are indicative of a more-permanent structural shift in the U.S. economy.9 While Yellen largely steered clear of the ongoing debate around inflation on Friday, she did note that “substantial progress has been made toward the Federal Reserve’s economic objectives of maximum employment and price stability.”13 While far from hawkish, the statement leaves the door open for another rate hike should recent economic data hold, with time enough to convince skeptical investors that another rate hike is in the offing in advance of December’s meeting.15
Chart of the week: Year-to-date trends in corporate credit
- As we move into the traditionally light trading week ahead of Labor Day and toward the homestretch of 2017, year-to-date performance trends within the corporate credit market this year are generally similar to those of 2016.
- Returns are more moderate across the spectrum this year, however both high yield bonds and senior secured loans are on track for another year of positive returns.16 As was the case in 2016, CCC rated bonds and loans continue to outperform higher-rated BB credits year to date.17,18
- Benefiting from generally supportive oil prices, still-low Treasury yields and limited volatility, high yield bonds have outperformed both senior secured loans and investment grade corporate bonds year to date.1,4,16,19
- Returns on senior secured loans have been relatively more limited as interest rate and inflation pressures have gradually moderated during the course of 2017.4,16,19
- Looking ahead, performance could hinge on the outcome of both economic and political matters. Investors will look to see if moderating inflation pressures indeed reflect “idiosyncratic factors,” as the Fed has noted, or if they are a more-permanent sign of slowing economic growth.9 Politically, investors have begun to train their eyes on the rhetoric surrounding Washington’s ability to avoid a potential government shutdown this fall.20
1 Federal Reserve Bank of St. Louis, http://bit.ly/295DSwP.
2 Bank of America Merrill Lynch High Yield Master II Index.
3 Thomson Reuters Lipper.
4 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
5 Credit Suisse Leveraged Loan Index.
6 J.P. Morgan High-Yield and Leveraged Loan Morning Intelligence, August 25, 2017.
7 The Financial Times, http://on.ft.com/2vnm8st.
8 Reuters, http://reut.rs/2wNb37T.
9 U.S. Federal Reserve, http://bit.ly/2wQAMtE.
10 Bloomberg, based on CME data.
11 Federal Reserve Bank of St. Louis, http://bit.ly/29ecFfc.
12 Bloomberg, https://bloom.bg/2wEOLG9.
13 U.S. Federal Reserve, http://bit.ly/2vvnFwc.
14 Bloomberg, https://bloom.bg/2vbF4yH.
15 U.S. Federal Reserve, http://bit.ly/29y0IjN.
16 Bank of America Merrill Lynch U.S. High Yield Master II Index, Credit Suisse Leveraged Loan Index, Bank of America Merrill Lynch U.S. Corporate Master Index, as of August 24, 2017.
17 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index, Bank of America Merrill Lynch U.S. High Yield BB rated Index.
18 CCC and BB rated components of the Credit Suisse Leveraged Loan Index.
19 Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
20 Roll Call, http://bit.ly/2w1Bplx.
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.