The corporate credit markets trended higher in the holiday-shortened week, as the global search for yield appeared to outweigh any lingering concerns around the British decision to exit the European Union. Investors continue to take an optimistic view regarding the resilience of the U.S. economy. Despite a decline in the price of oil and some volatility in equities, high yield bonds recouped all the declines sustained in the immediate aftermath of the Brexit vote, returning approximately 0.44% in the week ended July 7.1 The positive returns were fueled by broad-based gains across sectors, with high yield energy bonds posting a gain of approximately 0.65% as the high yield bond market continues to show signs of decoupling from oil prices.2 Notably, high yield bond mutual funds saw inflows of nearly $1.8 billion in the week ended July 6, more than reversing the $1.6 billion in outflows seen the week prior.3 For senior secured loans, prices gained in each of the past seven trading sessions despite a modest outflow from bank loan mutual funds. Year-to-date, senior secured loans are now providing returns of approximately 4.52%, as lower new issuance volume and ongoing institutional demand have continued to underpin secondary market prices.4 Although senior secured loans began 2016 at 7.53%, their current yield of 6.44% is approximately 0.38% higher than their five-year average.5
Investors were looking to Friday’s nonfarm payrolls report to confirm whether May’s dismal jobs report was an aberration or a sign of a broader economic slowdown.6 At 287,000, however, June’s jobs growth signaled renewed momentum, dovetailing with other positive U.S. economic data out this week, and reinforced an improved U.S. economic outlook heading into the second half of 2016.7 While the unemployment rate ticked slightly higher to 4.9%, it rose because more Americans entered the workforce in June. Meanwhile, average hourly earnings rose 2.6% year-over-year, suggesting some further tightening in the labor market. June’s nonfarm payrolls report, coupled with the highest ISM non-manufacturing survey in eight months, contradicted the recent flattening in the U.S. Treasury yield curve.8 After declining to a record low 1.3% on Wednesday, the yield on the 10-year U.S. Treasury Note turned higher following Friday’s stronger-than-expected labor market report.9Spiking to above 1.4% on Friday morning, the 10-year U.S. Treasury yield nevertheless remains approximately 0.87% below where it stood at year-end 2015, as historically low global interest rates continue to drive investors toward the relatively higher yields of U.S. fixed income assets.
Wait and see
Although the minutes of the U.S. Federal Reserve’s June policy meeting adopted a dovish tone, few conclusions could be drawn about the central bank’s economic outlook and where interest rates proceed from here.10 Instead of drawing conclusions from May’s surprisingly weak employment report and signaling when it expects to resume its path of tightening, the U.S. Fed adopted a wait-and-see approach, reiterating that economic data will drive any decision on interest rates in the months ahead. Moreover, any newsworthy moments stemming from the June 14-15 meeting were rendered less informative for having taken place before the U.K. referendum and Friday’s surge in nonfarm payrolls. Ahead of this week’s payrolls report, an interest rate hike at the next few FOMC meetings appeared to be squarely off the table. Now, investors see improved odds of at least one rate hike in 2016.11 Next week provides a fresh read on the U.S. economy, with the start of second quarter corporate earnings season, new data on U.S. inflation and June retail sales.12
Chart of the week: Keep calm and carry on
- Investors continued to feel the ripple effects from June’s Brexit vote this week as yields on government bonds hit new lows, concerns surrounding the health of European banks reemerged, and a number of U.K. property funds suspended redemptions.
- The post-Brexit market volatility also has produced a meaningful divergence in opinion between investors and fund managers on the impacts that the United Kingdom’s vote will have on portfolio performance in the coming 12 months and beyond.
- Based on a Preqin investor survey of 142 alternative investment firms and 50 global institutional investors, fund managers expect Brexit to have a significantly milder impact on the performance of investment portfolios than investors do.13
- Nearly 60% of alternative fund managers polled view Brexit as having either no impact, or a positive impact, on the performance of their portfolios. Just 16% expect the event to have a negative impact on performance. Alternatively, nearly double the amount of investors polled (29%) expect Brexit to have a negative impact on portfolio performance.
- This divergence illustrates a tendency among investors to let emotions and short-term market volatility effect long-term investment decisions.
- Bank of America Merrill Lynch High Yield Bond Index
- Bank of America Merrill Lynch High Yield Energy Index
- Thomson Reuters Lipper
- Credit Suisse Leveraged Loan Index
- Credit Suisse Leveraged Loan Index (based on a three-year maturity)
- U.S. Department of Labor: http://bit.ly/29t3PbK
- U.S. Department of Labor: http://bit.ly/1gck641
- Institute For Supply Management: http://bit.ly/1OVnkqn
- Federal Reserve Bank of St. Louis: http://bit.ly/29ecBfp
- U.S. Federal Reserve: http://bit.ly/29jjGJf
- Bloomberg based on CME Group data
- Econoday: http://bit.ly/29nRtj9
- Preqin Investor Survey, July 2016
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.