Corporate credit prices rose this week amid another record high for U.S. stocks, rising oil prices and ongoing investor demand for higher-yielding investments.1,2,3 Despite a rise in U.S. Treasury yields, high yield bond prices reacted favorably to the Republican-led tax plan and a firmer backdrop for energy credit.4 High yield bonds gained approximately 0.23% over the past week and are now providing returns of approximately 0.81% in September.4 After underperforming in August, CCC rated bonds are again outperforming their higher rated peers. Month-to-date, they are providing returns of approximately 1.41% as investors continued to move down the capital structure in search of yield.5 For perspective, CCC rated bonds are providing year-to-date returns of approximately 9.61%, easily outperforming both B rated bonds (6.26%) and BB rated bonds (6.73%).5,6,7 Senior secured loan prices also moved higher this week, with the asset class gaining approximately 0.13% as bank loan mutual funds registered a mild weekly outflow.8,9 Senior secured loans are now providing returns of 0.40% in September, outperforming more rate-sensitive investments such as investment grade bonds (-0.31%), U.S. two-year Treasury bonds (-0.10%) and U.S. 10-year Treasury notes (-1.46%).8,10,11,12
Firmer energy backdrop
Oil prices remained a focus this week, with oil prices briefly hitting a two-year high early in the week after Turkish President Erdogan responded to a Kurdistan independence referendum by threatening to close off a pipeline that carries approximately 500,000 barrels of oil a day.2,13 The potential decline in supply comes amid other data pointing to rising demand and a decline in oil inventories. Earlier this month, the International Energy Agency raised its demand growth estimate for 2017 and the U.S. Energy Information Administration lowered its projections for U.S. oil output.14,15 Other data released this week also indicated a rebalancing, with the EIA recording an unexpected 1.8 million-barrel decline in oil inventories in the week ended September 22, and the number of oil drilling rigs falling by five over the past week.16,17 Against this firmer backdrop for oil, energy credit has been an outperformer this month, with energy high yield bonds and energy senior secured loans returning approximately 3.38% and 1.48%, respectively.18,19
Treasury prices this week were driven lower by economic data, Fed Chair Yellen’s speech before The National Association for Business Economics and the Republican-led tax plan. While a sharper-than-expected rise in durable goods orders and a slight upward revision to second quarter GDP painted a solid picture of economic growth, the core personal consumption expenditures (PCE) price index released Friday indicated an ongoing lack of inflation.20,21,22 While Yellen acknowledged significant uncertainty around longer-run inflation expectations, she seemed to reaffirm investors’ expectations for a December rate hike, noting that, “it would be imprudent to keep monetary policy on hold until inflation is back to two percent.”23 While U.S. government bonds registered a somewhat muted reaction to Yellen’s speech, yields rose across the curve on the prospect that lower corporate taxes will help spur growth.24 While providing an overall framework, some details of the new tax plan remained missing.25 Of note to corporate borrowers, while the plan allowed for immediate write-offs of business investment for at least five years, it did not indicate what happens after those five years have expired.25 Moreover, while the plan seeks to limit a company’s ability to deduct its interest expense, it provided no further details on how the deductibility rule would look once it is changed.25
Chart of the week: Energy bonds offer a yield premium
- Yields across the corporate credit market have declined over the past year as investors continue to demand income-oriented investments. Even within today’s lower-yield environment, however, energy stands out as one of the few sectors that has continued to offer investors the opportunity to generate attractive yields.
- Even after a recent decline, yields on high yield energy bonds offer a premium of nearly 100 basis points over the broader high yield bond index.26 Similarly, energy senior secured loans’ yield of approximately 10.86% is nearly 5% above that of the Credit Suisse Leveraged Loan Index.27
- Energy’s yield premium remains relatively high even as the sector appears to be recovering from oil’s long-standing supply glut. For example, investors have adopted a more optimistic tone toward energy investments given recent evidence that OPEC’s production cuts, combined with the IEA’s latest upward revision to global demand, may be helping to bring the market closer to equilibrium.28
- Oil prices have moved into bull market territory, rising approximately 22% from their June 21 low of $42.31 per barrel, and credit prices have recovered sharply month to date.29 In September, BB, B and CCC energy bonds are returning +1.82%, +2.87% and +8.09%, respectively.30
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
3 Thomson Reuters Lipper, high yield bond mutual fund flows.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index.
6 Bank of America Merrill Lynch U.S. High Yield B Rated Index.
7 Bank of America Merrill Lynch U.S. High Yield BB Rated Index.
8 Credit Suisse Leveraged Loan Index.
9 Thomson Reuters Lipper, bank loan mutual fund flows.
10 Bank of America Merrill Lynch U.S. Corporate Master Index.
11 Bank of America Merrill Lynch U.S. 2-Year Treasury Bond Index.
12 Bank of America Merrill Lynch U.S. 10-Year Treasury Note Index.
13 Investment Week, http://bit.ly/2k8cAk1.
14 International Energy Agency, http://bit.ly/1ylJ2td.
15 MarketWatch, http://on.mktw.net/2wWQKoI.
16 U.S. Energy Information Administration, http://bit.ly/1V2gPZQ.
17 Baker Hughes, http://bit.ly/1BMeq7M.
18 Bank of America Merrill Lynch U.S. High Yield Energy Index.
19 Credit Suisse Leveraged Loan Index (Energy Component).
20 CNBC, http://cnb.cx/2fzWs9r.
21 Bureau of Economic Analysis, http://bit.ly/1DqcVBJ.
22 Bureau of Economic Analysis, http://bit.ly/2xLGjEm.
23 The U.S. Federal Reserve, http://bit.ly/2yqqBvX.
24 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
25 The Wall Street Journal, http://on.wsj.com/2yy5Dei.
26 Yield-to-worst on the energy component of the J.P. Morgan High Yield Bond Index, as of September 28, 2017.
27 Yield to 3-Year takeout on the energy component of the Credit Suisse Leveraged Loan Index, as of September 28, 2017.
28 International Energy Agency, http://bit.ly/1ylJ2td.
29 West Texas Intermediate Cushing Crude Oil Spot Price, as of September 28, 2017.
30 BB, B, and CCC rated components of the J.P. Morgan High Yield Energy Index, as of September 28, 2017.
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