Follow the polls
Movements of credit, equity and commodity markets this week closely tracked polls surrounding Thursday’s referendum in which voters in the United Kingdom elected to exit the European Union, surprising betting and financial markets. Prior to the vote, most polls had indicated that the referendum remained too close to call. As the week progressed, however, investors cheered increasing momentum in poll results that indicated the “remain” vote was favored and, in doing so, drove assets up. Just one week after yields on the sovereign debt of many developed countries reached all-time lows, the yield on 10-year German bunds rose 117 basis points, climbing back into positive territory, while the 10-year Treasury note moved up 17 basis points, to 1.74%, for the week ended June 23.1

Trading volume was light across most markets as investors awaited the results of Thursday’s vote, yet equity and high yield bond markets moved sharply higher, delivering returns of 1.71% and 1.54%, respectively, for the week.2,3 Senior secured loans turned in comparatively modest returns, moving up 0.19% for the week.4 Year to date, senior secured loans and high yield bonds are returning approximately 4.5% and 9.7%, respectively. Both asset classes have been boosted by the strong bounce back in commodities this year, with the metals/minerals and energy industries generating double-digit returns across both loans and bonds.4 Investor demand for bank loan mutual funds remains healthy as fund flows were mildly positive for the week ended June 23, adding to the more than $300 million of net inflows into bank loan mutual funds in May and June.5,6

Over and out
In choosing to leave the European Union, British voters delivered a huge surprise to the markets and caught investors flat-footed. As of Friday morning, the immediate impacts of the vote caused a tremendous amount of volatility in the markets, with stocks in Asia, Europe and the United States abruptly reversing their earlier gains of the week. Oil prices shed more than 5% and the British pound traded at its lowest level versus the U.S. dollar since 1985.7 Sovereign debt yields across the developed market landscape, which had risen earlier in the week, declined to levels never before seen in the case of 10-year German bunds and U.S. Treasury notes.1 The results of the vote also have unleashed significant political uncertainty, with British Prime Minister David Cameron resigning and the viability of the European Union in question.

Below average
For the second week running, Fed Chair Janet Yellen provided the most meaningful domestic economic headlines of the week. Just one week after pointing to structural, persistent forces that could keep interest rates lower for longer, Yellen reinforced a similar message in appearances before Congress on Tuesday and Wednesday. While Yellen spoke of her optimism that we will “see further improvements in the labor market and the economy more broadly over the next few years,” she continued to emphasize the downside risks and considerable uncertainty that the economy currently faces.8 Once again, in identifying factors that could depress interest rates below their longer-run levels, she pointed to the effects of slow productivity growth domestically along with international developments including slow growth in China as well as the now-complete U.K. Brexit vote. Yellen’s recent appearances have been notable insofar as she has added subtle qualifiers to her long-held view that headwinds to economic growth would diminish over time.

Market expectations of monetary policy shifted dramatically in light of the week’s events. As recently as Thursday, investors had allotted a 10% probability that the FOMC would raise the federal funds rate at its July meeting and a 33% probability of a rate hike at the September meeting. One day later, the implied probability of a rate hike is 0% for each of the July, September and November meetings and rises to just 9.9% for the December 2016 meeting.1 Notably, the implied probability of a rate cut at one of this year’s remaining meetings climbed from 0% on Thursday to up to 15.5% on Friday morning.

Chart of the week: Cutting the fat

  • Oil prices climbed above the $50 mark once again this week before falling on Friday morning in line with other risk assets. Even after Friday’s decline, prices have risen approximately 90% from their low point in mid-February 2016.9
  • In an interview this week, Saudi Arabia’s new energy minister highlighted a further bullish case for oil going forward, noting that the supply glut largely responsible for the steep drop in oil prices over the past 12 months has now “disappeared.”10
  • Producers have shown initial signs of growth again within today’s higher-price environment. Thanks to cost-cutting measures that upstream producers implemented during the downturn, many producers appear to be entering the next phase of the recovery as far leaner, more efficient operators than they were before oil prices collapsed.
  • According to IHS, the upstream operating cost index, which measures expenses in the oil and gas field operations arena, has declined nearly 20% from the second quarter of 2014.11 It is the first sustained decline in the index since data became available in 2000.
  • Reduced costs, combined with advances in drilling technologies, could provide an additional tailwind to upstream operators if prices continue on an upward trend. Alternatively, lower operating costs could help to shield producers if oil prices stagnate or decline again.

    1. Bloomberg
    2. S&P 500 Index
    3. Bank of America Merrill Lynch High Yield Master II Index
    4. Credit Suisse Leveraged Loan Index
    5. J.P. Morgan Morning Intelligence, June 24, 2016
    6. Thomson Reuters Lipper
    7. The Wall Street Journal,
    8. Federal Reserve,
    9. West Texas Intermediate Cushing Crude Oil Spot Price Index
    10. Fuelfix,
    11. IHS,

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