High yield bonds weaken, senior secured loans remain stable
Corporate credit prices were mixed this week as investors absorbed an assortment of third-quarter earnings, solid economic data and rising 10-year U.S. Treasury yields.1,2,3 High yield bond prices declined slightly toward week’s end as a rise in government bond yields weighed on sentiment, with the asset class recording a modest loss during the week ended October 26.4 Month to date, high yield bonds have returned approximately 0.36%, helped by rising stock prices, higher energy prices and growing optimism around the Republican-led tax plan.4,5,6,7 After declining to a year-to-date low of 5.37% earlier in the week, high yield bond yields have since widened nearly 0.10% to approximately 5.46%.8 For perspective, this compares to a multi-year high of 10.10% in February 2016.8 Senior secured loans posted a modest gain this week amid growing certainty around a December interest rate hike and rising U.S. government bond yields.9 Month to date, senior secured loans are providing returns of approximately 0.64%, on pace for the asset class’s strongest monthly performance since July.9 For perspective, investment grade corporate bonds, U.S. 2-year Treasuries and U.S. 10-year Treasuries are providing month-to-date returns of approximately -0.10%, -0.12% and -0.93%, respectively.10,11,12
U.S. government bond yields rise on solid economic data
U.S. government bond yields rose on the back of solid U.S. economic data, growing anticipation around the identity of the next U.S. Federal Reserve chair and increased optimism around tax reform.13,14 The U.S. 10-year Treasury yield rose to a seven-month high this week as investors continued to weigh the prospect of a more hawkish Fed chair once Janet Yellen’s term ends in February.3 Front-runners for the job are reported to be Stanford economist John Taylor and Federal Reserve Governor Jerome Powell, with Taylor thought to be the more hawkish of the two.13 Meanwhile, prospects for U.S. tax reform improved after the House of Representatives passed the Senate-backed budget resolution Thursday, clearing an important hurdle toward passing a tax bill.14 Against this backdrop, the U.S. 10-year Treasury yield rose briefly to 2.47% and the U.S. 2-year Treasury yield hit a nine-year high before slipping toward week’s end on reports that President Trump is leaning towards Powell as his choice to be the next Fed chair.3,15,16
Q3 GDP better than expected, inflation remains muted
Investors received a fresh look at U.S. economic growth this week, with the U.S. Commerce Department reporting the economy grew at a 3.0% annualized rate during the third quarter.17 The advanced estimate was stronger than expected and marks the U.S. economy’s best six-month stretch since mid-2014, helped by strong business investment and rising inventories.17 Elsewhere in the report, the price index for personal consumption expenditures (PCE) rose at an annual rate of 1.5% in the third quarter, while core prices rose 1.3%.17 Although both numbers showed a pickup in inflation, the report showed prices are still lagging well behind the Fed’s 2% goal.18 The GDP figure represents the last major piece of economic data to come out before the Fed meets next week and is thought to keep the central bank on the path to raising interest rates again at its December meeting.19 As of Friday morning, federal funds futures indicated an 87% likelihood of a rate hike before year-end.20
Chart of the week: Crude oil drawdowns supporting prices
- After four straight weeks of drawdowns, U.S. crude oil inventories unexpectedly rose this week.21 Investors largely looked past the increase as other news from the U.S. Energy Information Administration’s Weekly Petroleum Status Report generally remained supportive of oil prices. Supplies of gasoline and distillates, for example, declined from a week earlier and both came in below their 2016 levels.21
- Taking a step back from the fluctuations of weekly data, a bigger picture is emerging of the positive fundamental backdrop supporting oil prices. OPEC member and oil-producing non-OPEC nations, for example, remain largely compliant with their agreement, initiated in November 2016, to cut supply. For each of the past two months, non-OPEC nations have exceeded their cutback targets while OPEC member nations have generally been on pace with theirs.22 This week, Saudi Arabia’s energy minister asserted that the country remains willing to do “whatever it takes” to bring global oil inventories down to their 5-year average.23
- Meanwhile, the U.S. is in the midst of its largest drawdown of crude oil supplies in more than 10 years.21 While U.S. stockpiles of crude oil have increased an average of approximately 22 million barrels each year since 2007, stockpiles this year have drawn down more than 21 million barrels.24
- We believe oil prices will likely continue to experience significant fluctuations through the coming months and years, yet one could see this year’s drawdown as laying the foundation for a more balanced supply/demand outlook.
1 The Wall Street Journal, http://on.wsj.com/2xs6q0k.
2 U.S. Census Bureau, http://bit.ly/1fKNCzo.
3 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
6 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
7 The Wall Street Journal, http://on.wsj.com/2gKYkwR.
8 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
9 Credit Suisse Leveraged Loan Index.
10 Bank of America Merrill Lynch U.S. Corporate Master Index.
11 Bank of America Merrill Lynch U.S. 2-year Treasury Note Index.
12 Bank of America Merrill Lynch U.S. 10-year Treasury Note Index.
13 The Wall Street Journal, http://on.wsj.com/2zBfqRs.
14 CNN, http://cnn.it/2zG88fl.
15 Federal Reserve Bank of St. Louis, http://bit.ly/2anGvQ0.
16 Bloomberg, https://bloom.bg/2yROVbq.
17 U.S. Commerce Department, http://bit.ly/1DqcVBJ.
18 The Wall Street Journal, http://on.wsj.com/2iFgVLa.
19 U.S. Federal Reserve, http://bit.ly/29y0IjN.
20 Bloomberg, based on CME data.
21 U.S. Energy Information Administration, as of October 26, 2017, http://bit.ly/2ySPILf.
22 Bloomberg, https://bloom.bg/2l3XhFN.
23 DailyMail, http://dailym.ai/2zGImra.
24 Based on the time periods from approximately January 1–October 20, from 2007 through 2017.
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