High yield bonds, senior secured loans post weekly gains
Corporate credit prices were mixed this week, with high yield bonds and senior secured loans posting modest gains and investment grade bonds posting a decline.1,2,3 Against the backdrop of a fresh four-year high for 10-year U.S. Treasuries and another volatile week for U.S. equities, high yield bonds generated a modest 0.19% gain during the week ended February 22, recouping the declines sustained the week before.1,4,5 U.S. high yield bond mutual funds recorded an outflow of approximately $335 million during the week ended February 21, which was a significant improvement over last week’s $6.3 billion outflow.6 Alongside heightened equity volatility and an approximately 20 basis point rise in U.S. 10-year Treasury yields, high yield bonds are providing returns of approximately -1.17% in February.1 Meanwhile, senior secured loans recorded another modest 0.09% gain this week, which brings the month-to-date gain to 0.06%.2 Benefiting from their floating rate coupon amid renewed investor attention to rising interest rates, senior secured loans remain one of the few fixed income investments providing a positive return in 2018.2 Year to date, senior secured loans are generating returns of 1.14% after returning 4.25% in 2017.2 By comparison, high yield bonds, investment grade bonds and U.S. 10-year Treasuries are providing year-to-date returns of -0.54%, -2.67% and -4.11%, respectively.1,3,7

Investors eye FOMC minutes for rate signals
Amid a relatively light U.S. economic calendar, investors focused on minutes from the U.S. Federal Reserve’s January meeting, looking for any indication that the central bank might accelerate its plan to raise interest rates.8 Although the minutes didn’t signal any immediate change to the Fed’s expected path of rate increases, investors appeared to focus on language that suggested certain participants now saw greater “upside risk that inflation could increase more than expected” and that “core PCE prices were forecast to rise notably faster in 2018” than in 2017.8 Recall that in December core personal consumption expenditures rose by a somewhat modest 1.5% from a year earlier.9 Since then, the January nonfarm payrolls report showed an improvement in average hourly earnings and the January Consumer Price Index report contained a stronger-than-expected rise in core prices.10,11 While only tentative evidence of stronger wage growth and rising inflation has emerged since the Fed’s January meeting, investors are increasingly on the lookout for any signs that the Fed might shift from three to four interest rate hikes in 2018.12

Government bond yields rise on rate concerns
Although there was little to suggest the Fed has revised higher its outlook for the longer-run neutral rate, bond investors appeared to initially seize on the more hawkish language contained within the minutes of the most recent Fed meeting.8 Beginning the year at 2.40%, U.S. 10-year Treasury yields briefly rose to 2.94%, their highest closing level since January 2014, before settling slightly lower by week’s end.4 Yields at the longer end of the curve also rose, with the U.S. 30-year Treasury bond yield rising above 3.20% for the first time since 2015, before declining over the next two days.13 The rise in Treasury yields comes just a week before the release of January PCE data and four weeks before the Fed’s next policy meeting on March 20–21.14 Federal funds futures now indicate a 23% chance that the Fed raises short-term rates four times by year-end, up from just a 10% chance at the beginning of the year.15 However, whether the Fed ultimately revises its projected path of interest rate hikes turns on the evolution of inflation data in the coming months and whether recent signs of nascent wage growth can be sustained.16

Chart of the week: Bond and loan performance during periods of rising rates

  • Interest rate movements have been one source of volatility within both equity and fixed income markets recently. With Wednesday’s release of the minutes from January’s Federal Reserve meeting, this week was no exception. The yield on the 10-year U.S. Treasury note rose approximately 6 basis points on Wednesday and reached a new four-year high, before settling later in the week.4
  • The move was largely a response to the FOMC’s acknowledgment that recent economic conditions may warrant a “gradual upward trajectory of the federal funds rate.”8 However, this week’s move was just a continuation of the trend that has prevailed in 2018 and, more generally, since interest rates’ recent low point in September 2017.4
  • While rising rates may often be considered anathema to fixed income investors, the chart tells a more complete story. Specifically, high yield bonds and senior secured loans, which typically feature lower durations than the investment grade fixed income market, have posted solid returns during periods of rising interest rates.17
  • High yield bonds and senior secured loans generated competitive returns in each of five periods sampled since 1990 when interest rates experienced short-term spikes that averaged approximately 1.4%.4,17 Senior secured loans’ and high yield bonds’ average total returns during those five periods were 8.4% and 6.8%, respectively, compared to an average total return of -0.8% for investment grade bonds.4,17

1 ICE BofAML U.S. High Yield Master II Index.
2 Credit Suisse Leveraged Loan Index.
3 ICE BofAML U.S. Corporate Master Index.
4 Federal Reserve Bank of St. Louis, 10-year yield, http://bit.ly/29ecBfp.
5 Federal Reserve Bank of St. Louis, S&P 500, http://bit.ly/2d3pN5b.
6 Thomson Reuters Lipper.
7 ICE BofAML U.S. 10-year Treasury Index.
8 U.S. Federal Reserve, http://bit.ly/2BII3R6.
9 Bureau of Economic Analysis, http://bit.ly/2GEDTsG.
10 U.S. Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
11 U.S. Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
12 MarketWatch, http://on.mktw.net/2ovHHFp.
13 Federal Reserve Bank of St. Louis, 30-year yield, http://bit.ly/29ecFfc.
14 Econoday, http://bit.ly/1iJOdAP.
15 Bloomberg, based on CME data.
16 MarketWatch, http://on.mktw.net/2FucURr.
17 Bloomberg as of February 22, 2018. Investment grade bonds represented by the Barclays U.S. Aggregate Index. High yield bonds represented by the ICE BofAML U.S. High Yield Master II Index. Senior secured loans represented by the Credit Suisse Leveraged Loan Index.

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