High yield bond prices decline as interest rates rise
Corporate credit markets were mixed this week as a steady rise in U.S. Treasury yields and an increase in inflation expectations outweighed investors’ optimism regarding corporate earnings and global economic growth.1,2,3 On Monday and Tuesday, U.S. stocks experienced their biggest two-day decline in more than six months and returned approximately -0.57% on the week.4 High yield bond prices also came under pressure this week, returning approximately -0.38%, which more than reversed the gains from the previous week.5 High yield bond mutual funds have experienced outflows of nearly $6 billion in the last three reporting weeks.6 This represents the most significant stretch of outflows since March 2017, when interest rates last peaked at approximately 2.60%.1,6 Despite the week’s price consolidation, high yield bonds generated competitive returns of approximately 0.66% in January.5 For the month, high yield bond returns outpaced those of investment grade bonds, which experienced a loss of approximately -0.91%.7 Following 2017’s trend, bonds at the lower end of the credit ratings spectrum generally led higher-rated high yield bonds for the month. For example, CCC rated bonds returned 1.95% in January compared to returns of 0.84% and 0.13% for B and BB rated bonds, respectively, during the same time frame.8,9,10
Bank loan mutual funds see continued inflows
This week, 10-year U.S. Treasury yields continued to move above last week’s multi-year high of 2.67%, reaching 2.83% on Friday morning.1 With interest rates steadily climbing in recent weeks and months, investors have focused again on the effects that rising interest rates typically have on fixed income investments. Senior secured loans have benefited from the asset class’s floating rate coupon and position as a potential hedge against the adverse effects of rising rates. Senior secured loans returned approximately 0.27% for the week ended February 1, and bank loan mutual funds experienced a second consecutive week of inflows into the asset class.6,11 In the last two reporting weeks, bank loan mutual funds have experienced inflows totaling approximately $546 million, ending a 14-week stretch of outflows from the asset class.6 For the month of January, senior secured loans returned approximately 1.08%.11 This represented senior secured loans’ highest monthly return since December 2016, when they returned 1.15%.11 Like high yield bonds, returns on lower-rated loans outpaced those of their higher-rated peers during the month. CCC rated loans returned 2.46% in January versus returns of 1.03% and 0.78% for B and BB rated bonds, respectively.12,13,14
U.S. Treasury yields reach a three-year high
The yield on the 10-year U.S. Treasury note reached its highest point since April 2014 this week, pushed higher by a slew of positive economic releases.1 The U.S. economy added a better-than-expected 200,000 jobs in January while wages grew at a year-over-year rate of 2.9%, its fastest pace since June 2009.15,16 Meanwhile, both consumer spending and consumer confidence edged up in their most recent reporting periods.17,18 While investors have recently focused on the possibility that accelerated global growth could spur inflationary pressures, data released Monday showed that economic improvements have not yet translated into higher inflation figures. For example, the year-over-year change in the personal consumption expenditures (PCE) index, the U.S. Federal Reserve’s preferred measure of inflation, declined from 1.8% to 1.7% in December.17 The core PCE remained unchanged at 1.5%.17 At its January meeting earlier this week, the FOMC kept the target federal funds rate unchanged at 1.25%–1.5%, but delivered what many investors viewed as a mildly hawkish statement.19 The yield on the 2-year U.S. Treasury note moved to nearly 2.17% on Friday morning, approximately 5 bps higher on the week and its highest point since June 2008.20 Federal funds futures have not yet fully priced in three rate hikes this year, though expectations have risen from approximately a 27% chance of at least three short-term interest rate hikes in 2018 to 38% on Friday morning.21
Chart of the week: At its first meeting of 2018, the Fed stays the course
- In recent weeks, investors have increasingly focused on the potential for accelerated economic growth to stoke inflationary pressures within the U.S. economy. January’s strong wage growth provided evidence that rising prices could indeed be a challenge on the horizon for investors.16 Yet PCE data showed no sign of inflationary pressures percolating within the U.S. economy. In fact, on a year-over-year basis, the PCE Index declined in December from one month earlier.17
- Within this context, the FOMC at its first meeting of 2018 maintained the target federal funds rate at 1.25%–1.5%.19 The meeting was Janet Yellen’s final as Fed Chair and was perhaps a fitting end to Ms. Yellen’s tenure, which has been marked by a slow and steady approach to raising rates throughout the economic recovery.
- In the current cycle, for example, the FOMC has raised the target federal funds rate five times for a total of 125 bps since it began tightening more than two years ago.22 If current projections hold true under the leadership of new Chair Jerome Powell, the target federal funds rate will rise another approximately 140 bps from now until 2021.23
- As the chart highlights, the current tightening path has been significantly slower and shallower than for any other hiking cycles since 1986.22 In that timeframe, the FOMC has engaged in five sustained rate hike cycles. The cycles have ranged from as little as a 150 bps hike over a 12-month period (starting in June 1999) to as much as the 425 bps increase that began in June 2004 and lasted for two years.22
- However, as recent economic growth estimates firm and average hourly wage data jumps, policymakers may face a significant test in 2018 as they seek to balance what has been their cautious approach toward raising rates with the potential for more robust economic growth and higher inflation expectations ahead.3,16
1 Federal Reserve Bank of St. Louis, 10-year Treasury Constant Maturity Rate, http://bit.ly/29ecBfp.
2 Federal Reserve Bank of St. Louis, 5-year, 5-year forward inflation expectation rate, http://bit.ly/2syTZBG.
3 International Monetary Fund, http://bit.ly/2DWDK3E.
4 S&P 500 Index.
5 ICE BofAML High Yield Master II Index.
6 Thomson Reuters Lipper, based on data from J.P. Morgan High-Yield and Leveraged Loan Morning Intelligence.
7 ICE BofAML U.S. Corporate Master Index.
8 ICE BofAML U.S. High Yield CCC and Lower Rated Index.
9 ICE BofAML U.S. High Yield B Rated Index.
10 ICE BofAML U.S. High Yield BB Rated Index.
11 Credit Suisse Leveraged Loan Index.
12 CCC rated portion of the Credit Suisse Leveraged Loan Index.
13 BB rated portion of the Credit Suisse Leveraged Loan Index.
14 B rated portion of the Credit Suisse Leveraged Loan Index.
15 Bureau of Labor Statistics, Employment Situation Summary, http://bit.ly/2iYbHWM.
16 Bureau of Labor Statistics, Average Hourly Earnings, http://bit.ly/2hbEN7I.
17 Bureau of Economic Analysis, Personal Income and Outlays, http://bit.ly/2mOhSP0.
18 The Conference Board, Consumer Confidence Index, http://bit.ly/1eu7yyH.
19 U.S. Federal Reserve, http://bit.ly/2rUvLSj.
20 Federal Reserve Bank of St. Louis, 2-year Treasury Constant Maturity Rate, http://bit.ly/2anGvQ0.
21 Bloomberg, World Interest Rate Probability.
22 U.S. Federal Reserve, Bloomberg, as of February 1, 2018.
23 U.S. Federal Reserve, Summary of Economic Projections, http://bit.ly/2Bh8q0L.
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