Corporate credit prices consolidate recent gains
Corporate credit prices were steady to slightly higher this week as investors absorbed another round of economic data suggesting steady growth coupled with low wage growth.1 High yield bond prices were relatively flat this week, consolidating a rally that began in mid-November.2 For context, high yield bonds have gained approximately 1.14% since November 15, erasing most of the declines experienced the first two weeks of the month.2 Year to date, high yield bonds are now providing returns of approximately 7.18%, with lower-rated bonds outpacing those that are higher up in the capital structure.2 Year to date, CCC rated bonds have returned approximately 9.76%, while B rated and BB rated bonds are providing returns of 6.43% and 7.03%, respectively.3,4,5 Following the large weekly outflow sustained three weeks ago, high yield bond mutual funds have seen modest inflows in each of the past two weeks for a combined $527 million over that span.6 Senior secured loans continued to grind higher this week, having gained approximately 0.42% since November 15 and are now providing a month-to-date gain of 0.11%.7 This week saw bank loan mutual funds experience another small outflow, the eighth consecutive week of outflows for a total of $3.3 billion over that span. Still, bank loan mutual fund flows remain positive for the year, with year-to-date inflows totaling $10.7 billion as investors continued to seek out floating rate, high-yielding investments.6 Following this week’s gains, senior secured loans are now providing returns of approximately 3.96% in 2017.7
U.S. 10-year yields trade in a narrow range amid subdued inflation
U.S. 10-year Treasury notes continued to trade in a narrow 10 basis point band this week amid another week of economic data showing steady, albeit slow, growth combined with subdued inflation pressures.8 Despite two rate hikes so far in 2017, and another expected next week, U.S. 10-year Treasury yields remain stubbornly below where they began the year as any signs of inflation have proved short-lived.8 This week saw further signs that low inflation may not be transitory as an upward revision to third quarter U.S. productivity coincided with a sharp downward revision to labor costs.9 U.S. Treasury yields ticked slightly lower after Labor Department data showed productivity rose at an annual pace of 3% in the third quarter, while unit labor costs declined unexpectedly.9 All told, labor costs fell at an annual rate of 0.2% in the third quarter, underscoring ongoing subdued inflation, prefiguring Friday’s nonfarm payrolls report that showed only a modest rise in wages in November.9,10
Jobs report shows tightening labor market, muted wage growth
Friday’s jobs report was the highlight of this week’s economic calendar, with November’s payroll numbers providing an undistorted look into the U.S. labor market following two hurricane-influenced months.10 In sum, U.S. employers added a higher-than-expected 228,000 jobs in November, and the headline unemployment rate remained steady at 4.1%. U.S. wage growth, however, remained muted, with average hourly earnings increasing only 0.2% month over month and 2.5% year over year.10 Altogether, it was another report showing strong growth in payrolls and a tightening labor market, coupled with muted wage growth.10 The jobs report appears to dovetail with market expectations of another rate hike at next week’s FOMC policy meeting, but only gradual rate increases thereafter.11 Next week’s economic calendar includes a fresh read on consumer prices and a December 13 interest rate decision from the U.S. Federal Reserve.12 At September’s meeting, the FOMC penciled in another three rate hikes in 2018 and revised down its projection of core inflation to 1.5% for the end of 2017.13 Next week’s meeting will provide a fresh set of economic projections and outlook for interest rates going forward.14
Chart of the week: Need for yield continues as 2018 uncertainty looms
- As Wall Street banks begin rolling out their annual market and economic outlooks for 2018, analysts look to a new year that carries with it perhaps more uncertainty, and a wider potential range of outcomes for credit markets, than recent years.15
- As we approach the ninth year of the current economic expansion, the Fed will likely continue tightening at a time when inflation has remained relatively muted.16 For its part, the European Central Bank appears set to begin unwinding its own bond-buying program.17
- At the same time, equity valuations are at or near historic highs by some measures, while yields across the corporate credit market remain very low.18,19 As the chart highlights, high yield bonds currently yield approximately just 5.8%, and have been below their 5-year average of approximately 6.3% since December 2016.20
- Given these conditions, corporate credit outlooks range widely. Some analysts show continued optimism, citing a still relatively supportive macro environment while others, who regard asset values across the corporate credit markets as high, call for a new round of spread widening.15
- Much about 2018 remains uncertain. What does seem reasonably likely, however, is that it should be another year in which income could remain at a premium. Though the Fed most recently projected that it will raise rates three times next year, the current tightening cycle remains notably more cautious and slow than earlier tightening periods.20
1 Federal Reserve Bank of St. Louis, Average Hourly Earnings, http://bit.ly/2vGwgMM.
2 ICE Bank of America Merrill Lynch U.S. High Yield Master II Index.
3 ICE Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index.
4 ICE Bank of America Merrill Lynch U.S. High Yield B Rated Index.
5 ICE Bank of America Merrill Lynch U.S. High Yield BB Rated Index.
6 Thomson Reuters Lipper.
7 Credit Suisse Leveraged Loan Index.
8 Federal Reserve Bank of St. Louis, 10-year Treasury yields, http://bit.ly/29ecBfp.
9 U.S. Bureau of Labor Statistics, http://bit.ly/2vpSbKZ.
10 U.S. Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
11 Bloomberg, based on CME data.
12 Econoday, http://bit.ly/1iJOdAP.
13 U.S. Federal Reserve, http://bit.ly/2jcHEiW.
14 U.S. Federal Reserve, http://bit.ly/29y0IjN.
15 Bloomberg, https://bloom.bg/2ABD2Jr.
16 Bureau of Economic Analysis, http://bit.ly/2mOhSP0.
17 European Central Bank, http://bit.ly/2gLTDD7.
18 Robert Shiller, Yale University, http://bit.ly/1qlZ47U.
19 Bloomberg, based on the yield-to-worst of the Bank of America Merrill Lynch U.S. High Yield Bond Index, as of December 7, 2017.
20 U.S. Federal Reserve, http://bit.ly/2fjuEX3.
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.