Corporate credit prices were modestly higher this week against the backdrop of rising equities, stronger U.S. retail sales data and another benign inflation reading.1,2,3 High yield bonds returned approximately 0.01% this week as inflows into high yield bond mutual funds recorded an inflow of approximately $967 million during the week ended October 11.4,5 It was the fourth straight weekly inflow, totaling over $2.9 billion over that span.5 Month to date, high yield bonds are now providing returns of approximately 0.17% amid optimism surrounding the release of the Republican-led tax plan and ongoing investor appetite for yield.4 High yield bond yields rose 5 basis points over the past week to 5.51%, which is comparable to a multi-year low of 5.40% in late July.6 Year to date, high yield bonds are providing returns of approximately 7.23%, with CCC rated bonds (9.86%) a notable outperformer.4,7 Senior secured loans registered a modest gain this week as bank loan mutual funds recorded their second straight weekly inflow, bringing total inflows to more than $414 million over that span.5,8 Year to date, senior secured loans are now providing returns of approximately 3.40%, with the metals and mining (4.73%) and the energy (4.54%) subsectors both notable outperformers.8,9,10
U.S. government bond yields held relatively steady immediately following Wednesday’s release of minutes from the U.S. Federal Reserve’s September meeting.11 Notes from the meeting were largely in line with analyst expectations, showing that most officials are leaning toward raising short-term rates once more in 2017, but will continue to monitor inflationary trends.12 Aligning closely to the main messages delivered in September’s policy statement, some officials said their decision on another rate hike this year “would depend importantly on whether the economic data in coming months increased their confidence that inflation was moving up toward the Committee’s objective” of 2%.12,13 The key question for Fed officials is whether the recent soft patch in inflation is temporary or whether it reflects longer-lasting, structural developments. This would seem to put added emphasis on this week’s September Consumer Price Index (CPI) report, as well as on those in the months leading up to December’s FOMC policy meeting.3
Largely due to a rise in gasoline prices in the wake of Hurricane Harvey, the CPI rose 0.5% in September from a month earlier, against analyst expectations of a rise of 0.6%.14 Overall, prices rose 2.2% in the 12 months through September, up from 1.9% in August.3 While consumer prices rose steadily for the second straight month, much of the rise was due to temporary, energy-driven factors.3 Core prices rose just 0.1% month over month and 1.7% from a year earlier.3 If the CPI data proved slightly disappointing, U.S. retail sales showed solid gains, rising 1.6% in September on the back of higher car sales and gasoline prices.2 While part of the rise reflected temporary, hurricane-related effects, sales at U.S. retailers have been modestly positive throughout 2017.2 In another positive sign for spending, the University of Michigan Consumer Sentiment Index rose to a 13-year high in October.15 While the Fed is likely to view the energy-driven rise in this week’s CPI figures as temporary, stronger U.S. retail sales and elevated consumer confidence could translate into solid growth and increased spending in the months ahead.
Chart of the week: Fed rate hikes – more cautious and slow
- Many investors continue to expect a third rate hike in 2017. The market-implied probability of a rate hike at the Fed’s December meeting, for example, has increased from approximately 23% in early September to nearly 80% this week before falling slightly just after Friday’s CPI report was released.16
- If the FOMC indeed follows through on its estimates, investors can expect one additional rate hike this year and three more in 2018.17 Yet the current rate hike cycle stands out from others over the past 30 years as the FOMC has been notably more cautious and slow in the current cycle than in earlier tightening periods.
- Since 1986, the FOMC has engaged in five sustained rate hike cycles. The cycles have ranged from as little as a 150 basis point hike over a 12-month period (starting in June 1999) to as much as the 425 basis point increase that began in June 2004 and lasted for two years.18
- In the current cycle, the FOMC has raised the target federal funds rate five times for a total of approximately 125 basis points since it began tightening nearly two years ago.18 If current projections hold true, the target federal funds rate would rise another approximately 175 basis points between now and 2021.17
- Even as many policymakers discuss the need to raise rates, it is important to keep in mind, as New York Fed President William Dudley noted in a recent speech, that the “upward trajectory of the policy rate path should continue to be shallow” in order to keep the economy on a sustainable path for growth.19
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 U.S. Department of Commerce, http://bit.ly/Y4FaTF.
3 Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Thomson Reuters Lipper.
6 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
7 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index
8 Credit Suisse Leveraged Loan Index.
9 Credit Suisse Leveraged Loan Index (metals and mining component).
10 Credit Suisse Leveraged Loan Index (energy component).
11 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
12 U.S. Federal Reserve, http://bit.ly/2xzzCSA.
13 U.S. Federal Reserve, http://bit.ly/2yrVfFY.
14 The Wall Street Journal, http://on.wsj.com/2yeQSRl.
15 University of Michigan, http://bit.ly/1gDEQwe.
16 Bloomberg, based on CME data.
17 Federal Reserve Summary of Economic Projections, http://bit.ly/2fjuEX3.
18 U.S. Federal Reserve, Bloomberg as of October 12, 2017.
19 Federal Reserve Bank of New York, http://nyfed.org/2i5m9j3.
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