Corporate credit prices mixed amid U.S. Treasury volatility
Corporate credit prices were mixed this week as U.S. Treasury volatility and tariff-related equity volatility sapped some investor demand toward week’s end.1,2 High yield bond prices rose at the outset of the week only to slip again amid Thursday’s sharp selloff in equities, as uncertainty around trade spilled into the broader financial markets.3 As a result, high yield bonds recorded their fourth consecutive weekly decline and posted their first monthly decline since November.3 High yield bonds returned -0.93% in February, the largest decline in 26 months, erasing all the gains of January.3 Amid increased interest rate sensitivity, high yield bond mutual funds recorded an outflow of approximately $702.9 million during the week ended February 28, bringing February’s net outflow to more than $10.4 billion.4 Senior secured loans experienced a modest gain this week despite the broader market volatility, capping off a February in which the asset class recorded a gain of 0.20%.5 Benefiting from their floating rate coupon and position as a potential hedge against rising interest rates, senior secured loan prices have continued to appreciate since the outset of 2018 even as bond prices declined.3,5,6 For context, senior secured loan prices are up $0.65 since December 31, 2017, versus a $1.45 decline in high yield bond prices and a $3.18 decline in investment-grade bond prices.3,5,6
Volatility rises on inflation concerns, tariff-related jitters
U.S. government bond yields experienced heightened volatility this week amid a confluence of inflation concerns and investor worries around a potential global trade war following President Trump’s pledge to impose tariffs on steel and aluminum imports.1 The combination sent U.S. 10-year Treasury yields as high as 2.92% on Tuesday and as low as 2.78% on Thursday.1 U.S. government bond yields rose sharply after U.S. Federal Reserve Chair Powell told Congress that he has become more optimistic about the U.S. economy and that the central bank remains on track to gradually hike short-term interest rates.7 “Some of the headwinds the U.S. economy faced in previous years have turned into tailwinds,” he said. “In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory.”7 Bond investors took this as a sign that the Fed could lift interest rates four times instead of three in 2018, sending government bond yields higher before declining later in the week after Powell appeared to dial back those expectations during his second day of testimony.8
February nonfarm payrolls report a focus in week ahead
Aside from Chair Powell’s testimony on Capitol Hill, this week’s economic calendar included both the price index for personal consumption expenditures (PCE) and Core PCE, the Fed’s preferred measure of inflation.9 The PCE advanced 0.4% in January from a month earlier and 1.7% from the year earlier, while Core PCE rose 0.3% and 1.5%, respectively. In his testimony, Powell said inflation readings had strengthened toward the end of last year and that he expects “that inflation on a 12-month basis will move up this year and stabilize.”7 Adding to the inflation narrative, the labor market showed further signs of tightening this week, with the number of new unemployment applications falling to its lowest level since December 1969.10 A combination of high consumer confidence, low unemployment and rising wages may help to lift inflation this year, with the next confirmation of wage growth coming next week with February’s nonfarm payrolls report and a revised Fed outlook on the U.S. economy coming at the FOMC’s March 20–21 meeting.11
Chart of the week: Equity volatility bounced in February, yet remains below average
- The S&P 500 Index generated its first negative total return in February since October 2016 as the equity and credit markets saw volatility bounce again.2 Returns on investment grade and high yield corporate bonds were also negative for the month, with high yield bonds experiencing their worst monthly performance since January 2016.3,6
- Following strong performances in January, markets largely pulled back as investors weighed the potential for a quicker pace of interest rate hikes by the FOMC amid signs of improved U.S. economic growth and renewed inflationary pressure.
- In mid-February, the CBOE Volatility Index (VIX), which measures investor expectations of near-term volatility, reached 37, its highest point since September 2011.12 The index later declined from its mid-month peak, but generally remained elevated, averaging approximately 22 for the entire month of February.12
- Despite the recent uptick in market volatility, 2018 has perhaps presented a more typical market environment than last year. For example, 2017 generally provided investors with strong market returns amid historically low levels of volatility.
- As the chart highlights, volatility can spike quickly and without notice. Given recent conditions, it may be wise for investors to proactively prepare for further volatility before it arrives.
1 Federal Reserve Bank of St. Louis, 10-year yield, http://bit.ly/29ecBfp.
2 Federal Reserve Bank of St. Louis, S&P 500, http://bit.ly/2d3pN5b.
3 ICE BofAML U.S. High Yield Master II Index.
4 Thomson Reuters Lipper.
5 Credit Suisse Leveraged Loan Index.
6 ICE BofAML U.S. Corporate Master Index.
7 U.S. Federal Reserve, http://bit.ly/2FA2csz.
8 Bloomberg, https://bloom.bg/2t5pwvL.
9 Bureau of Economic Analysis, http://bit.ly/2H08DES.
10 U.S. Department of Labor, http://bit.ly/298eR69.
11 Econoday, http://bit.ly/1iJOdAP.
12 CBOE Volatility Index, based on data from January 1990 through March 2018.
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