Corporate credit prices extend rise
Corporate credit prices rose this week amid rising U.S. equities, a firmer backdrop for energy and solid economic data.1,2,3 This week’s move solidifies a strong start to 2018 as stocks have continued to hit fresh records and oil prices increased to a three-year high.2,4 High yield bond prices extended last week’s gains and are now providing month-to-date gains of approximately 0.72%.5 High yield bond mutual funds experienced their second straight weekly inflow, pulling in approximately $2.65 billion during the week ended January 10.6 It was the largest weekly inflow since December 2016 and stands in contrast to the approximately $21.3 billion in outflows high yield bond mutual funds experienced in 2017.6 Alongside an increase in prices, high yield bond yields have tightened by approximately 14 bps since the beginning of the year and currently stand at approximately 5.70%.7 For perspective, that is up from a recent low of 5.37% in October.7 Senior secured loans are also off to a solid start to the year, providing month-to-date returns of approximately 0.56% after returning approximately 4.25% in 2017 and experiencing positive returns in 20 of the last 22 months.8
Energy credit rises alongside oil
Oil was once again in focus this week as rising crude prices contributed to a stronger backdrop for energy credit.2 Oil prices rose to another three-year high as geopolitical risks, improving global growth trends and declining U.S. stockpiles helped push prices briefly above $64 a barrel for the first time since 2015.2 Prices rallied after the U.S. Energy Information Administration reported a decline of 4.9 million barrels of oil for the week ended January 5.9 It was the eighth straight weekly decline for a total drop of approximately 36.5 million barrels over that span.10 High yield energy bonds and energy senior secured loans have responded positively to the recent uptick in oil prices and are outperforming their respective benchmark indices over the past month, returning approximately 2.09% and 1.14%, respectively.11,12 For perspective, high yield energy bonds and energy senior secured loans currently yield approximately 6.1% and 9.8%, respectively, compared to 8.3% and 10.5% in June 2015 when oil prices were last at current levels.13,14
Core CPI rises more than expected
With this week’s calendar light on economic data, investors were looking ahead to Friday’s U.S. retail sales and Consumer Price Index (CPI) for signs of inflation.15 The U.S. 10-year Treasury note yield approached a 52-week high earlier in the week, highlighting investors’ growing economic optimism and expectations about a shift away from aggressive global monetary stimulus.16 Some of this week’s rise in the U.S. 10-year Treasury yield could be attributed to the Bank of Japan’s announcement that it would trim its government bond purchases and news reports that China may view U.S. Treasuries as less attractive.17,18 However, at least some of the movement came from rising inflation expectations. Friday morning, Treasury yields rose across the curve, with the U.S. 2-year note rising above 2.0% for the first time since 2008, as December core CPI surprised to the upside.20,21 Overall, headline inflation rose 2.1% year-over-year and core CPI rose 1.8% year-over-year.21 Following the report, Fed funds futures indicated an 88% probability of a rate hike at the U.S. Federal Reserve’s March meeting, helping the spread between the 2-year and 10-year U.S. Treasuries to decline to 55 bps.22,23
Chart of the week: Inflation expectations have edged up recently
- Inflation expectations have slowly edged up in recent weeks, after reaching a low in June 2017. As the chart highlights, for example, the 5-year Breakeven Inflation Rate, which represents expected inflation over the 5-year period, has risen approximately 5 bps year to date and has nearly reached the 2% mark.19 Longer-term inflation expectations have remained just above 2% since the start of 2018.19
- Price expectations moved higher primarily on account of firming oil prices, which reached a three-year high this week, but also with continued solid economic data across the developed world and optimism surrounding the recently signed U.S. tax plan.24
- The yield on the 10-year Treasury note has risen for many of the same reasons as inflation expectations. This week, it neared the upper end of the 2.2%–2.6% band inside which it has traded since early 2017.25
- Even taking recent upward trends into account, however, each measure remains well in check when looking at them over a longer time period.
- Inflation expectations moved briefly above 2% in early 2017, but dipped back down through the remainder of the year and remain well below their post-crisis average.19 Likewise, the 10-year Treasury note remains within its recent cyclical trading range.25 Even after the Fed’s five rate hikes this cycle, however, the measure is comfortably under its post-crisis high.
1 Federal Reserve Bank of St. Louis, DJIA, http://bit.ly/2jZjDYt.
2 Federal Reserve Bank of St. Louis, WTI, http://bit.ly/292Tgue.
3 U.S. Census Bureau, http://bit.ly/Y4FaTF.
4 Federal Reserve Bank of St. Louis, S&P 500, http://bit.ly/2d3pN5b.
5 ICE BofAML U.S. High Yield Master II Index.
6 Thomson Reuters Lipper.
7 ICE BofAML U.S. High Yield Master II Index (yield-to-worst).
8 Credit Suisse Leveraged Loan Index.
9 U.S. Energy Information Administration, http://bit.ly/1V2gPZQ.
10 U.S. Energy Information Administration, http://bit.ly/2e0fwZV.
11 ICE BofAML U.S. High Yield Energy Index.
12 Credit Suisse Leveraged Loan Index (energy component).
13 ICE BofAML U.S. High Yield Energy Index (yield-to-worst).
14 Credit Suisse Leveraged Loan Index (energy component, yield-to-a-three-year maturity).
15 Econoday, http://bit.ly/1iJOdAP.
16 Federal Reserve Bank of St. Louis, 10-year yield, http://bit.ly/29ecBfp.
17 The Wall Street Journal, http://on.wsj.com/2DnUoZB.
18 The Wall Street Journal, http://on.wsj.com/2AUIkw3.
19 Bloomberg, based on the 5-year and 10-year breakeven inflation rates.
20 Federal Reserve Bank of St. Louis, 2-year yield, http://bit.ly/2anGvQ0.
21 Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
22 Bloomberg, based on CME data.
23 Federal Reserve Bank of St. Louis, 10-year minus 2-year, http://bit.ly/2oMWaP2.
24 Federal Reserve Bank of St. Louis, WTI oil prices, http://bit.ly/292Tgue.
25 Federal Reserve Bank of St. Louis, 10-year Treasury note, http://bit.ly/29ecBfp.
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