High yield bonds, senior secured loans gain in October
Corporate credit prices were relatively stable in a fairly busy week encompassing a U.S. Federal Reserve chair announcement, the release of the Republican-led tax bill, a Federal Open Market Committee (FOMC) policy meeting and the release of new nonfarm payrolls data.1,2,3,4 High yield bond prices moved largely sideways as investors absorbed a flatter yield curve, solid economic data and rising oil prices.5,6,7,8 High yield bonds recorded a modest gain this week, bringing October’s total return to 0.39%.5 For perspective, October’s gain represents the ninth monthly positive return over the past 11 months. 5 Year to date, high yield bonds are now providing returns of approximately 7.46%, with CCC rated bonds returning 9.72%, B rated bonds returning 7.00% and BB rated bonds returning 7.20%.5,9,10,11 High yield energy bonds continued to outperform the benchmark index in October, posting a gain of approximately 0.85% as oil prices approached a 10-month high.8,12 Senior secured loans also posted a modest gain this week, capping off an October in which the asset class returned approximately 0.66%.13 For perspective, October’s gain represents the second highest monthly gain for the asset class in 2017, with the energy (1.49%) and the utility (1.17%) subsectors outperforming in October.14,15
U.S. Fed signals only gradual increases ahead
U.S. Federal Reserve officials began their two-day policy meeting Tuesday amid fresh signs that inflation remains low despite other economic data suggesting solid economic growth.16,17 With no post-meeting press conference or updated economic forecasts, all signals regarding the future path of interest rates came from the statement itself.3 To that end, the statement did little to alter the view that a December rate hike remains likely, with federal funds futures currently indicating a 92% chance of a rate hike before year’s end.18 Following last week’s stronger-than-expected 3.0% U.S. GDP figure, the FOMC’s statement sounded relatively upbeat on growth, noting that “economic activity has been rising at a solid rate despite hurricane-related disruptions.”3 However, Fed officials continued to anticipate only “gradual increases in the federal funds rate.”3 Meanwhile, the choice of Jerome Powell as the new Fed chair suggests a continuance of the U.S. central bank’s gradual approach to raising short-term interest rates even after Janet Yellen’s departure in February.1
Inflation remains subdued despite solid U.S. economic data
Recent economic data has painted a somewhat optimistic picture of the U.S. economy. This week saw a gauge of consumer confidence rising near a 17-year high and the unemployment rate falling to a 17-year low.19,4 Nevertheless, signs of inflation remain low. While the price index for personal consumption expenditures (PCE) rose 1.6% on an annual basis in September, core prices were up just 1.3%, well below the Fed’s 2% target.16 And while U.S. payrolls rebounded in October, average hourly earnings fell by 1 cent, or 0.04%, in October.4 Despite a notable lack of inflationary pressure, other areas of the October nonfarm payrolls report suggested a further tightening in labor markets and solid economic growth.4 Though distorted due to hurricane-related payback, nonfarm payrolls rose by 261,000 in October and the unemployment rate declined to 4.1%.4 With inflation still subdued and all signs that the Fed is on track to raise short-term interest rates in December, U.S. government bonds yields flattened across the curve.6 As of Friday, the yield difference between the U.S. 2-year and 10-year Treasury notes was sitting at a 10-year low.6
Chart of the week: The number of U.S. oil rigs has leveled off
- Oil prices climbed above $54 per barrel this week as market fundamentals appeared to show continued improvement.20 According to the U.S. Energy Information Administration’s Weekly Petroleum Status Report, stockpiles of U.S. gasoline experienced a greater-than-expected weekly decline of more than 4 million barrels.21 After sitting well above their 5-year range for nearly all of 2016, gasoline stockpiles moved squarely into the middle of the longer-term average this week.21
- At the same time, reports emerged this week that OPEC is likely to continue its agreement with non-member nations to curb oil production through the entirety of 2018.22 The agreement was originally slated to end in March 2018; however, leaders of OPEC have been encouraged by high compliance rates, and Saudi Arabia, in particular, has been vocal about the need to further reduce inventories.22,23
- At earlier points in the current cycle, investors might have expected smaller domestic producers to boost their output, taking advantage of recent price increases. Based on recent data, however, the U.S. oil rig count appears to have peaked in August 2017.24 Since then, the number of rigs in the U.S. has declined by 31 – a small figure, but a decline that highlights the broader trend through the second half of this year.24
- Because rig count is typically viewed as a proxy for activity within the sector, it could potentially become harder for U.S. producers to quickly ramp up supply in the coming months.
- Wall Street analysts have taken note of recent fundamental improvements underlying the oil market. In late October, a group of analysts polled by The Wall Street Journal raised their oil-price forecasts for the first time in six months.25
1 The Wall Street Journal, http://on.wsj.com/2yslhMI.
2 The Wall Street Journal, http://on.wsj.com/2zZsujM.
3 U.S. Federal Reserve, http://bit.ly/2ilhF4q.
4 Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
5 ICE Bank of America Merrill Lynch U.S. High Yield Master II Index.
6 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
7 Bureau of Economic Analysis, http://bit.ly/1DqcVBJ
8 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
9 ICE Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index.
10 ICE Bank of America Merrill Lynch U.S. High Yield B Rated Index.
11 ICE Bank of America Merrill Lynch U.S. High Yield BB Rated Index.
12 ICE Bank of America Merrill Lynch U.S. High Yield Energy Index.
13 Credit Suisse Leveraged Loan Index.
14 Credit Suisse Leveraged Loan Index (energy component).
15 Credit Suisse Leveraged Loan Index (utility component).
16 Bureau of Economic Analysis, http://bit.ly/1cR0IcA.
17 Bureau of Economic Analysis, http://bit.ly/1DqcVBJ.
18 Bloomberg, based on CME data.
19 The Conference Board, http://bit.ly/1eu7yyH.
20 Bloomberg West Texas Cushing Crude Oil Spot Price, as of November 3, 2017.
21 U.S. Energy Information Administration, http://bit.ly/2ueQorn.
22 Reuters, http://reut.rs/2za9fFc.
23 Bloomberg, https://bloom.bg/2l3XhFN.
24 Baker Hughes North America Rig Count, http://bit.ly/1BMeq7M.
25 The Wall Street Journal, http://on.wsj.com/2z4Wv2q.
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