Credit market commentary: May 2018

Data as of May 31, 2018 unless otherwise noted

Performance (total returns)

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Mixed month for high yield bonds and senior secured loans: The leveraged credit markets were mixed in May, with high yield bonds posting a modest decline and senior secured loans recording a gain for the ninth consecutive month. For the ICE BofAML U.S. High Yield Master II Index (HY Bonds), this was the third monthly decline of 2018 as higher volatility in U.S. equity contributed to some caution among high yield bond investors.¹ Investor fund flows turned negative in May, with high yield bond mutual funds now recording an outflow in seven of the past eight months.² The S&P/LSTA Leveraged Loan Index (senior secured loans) posted a modest gain and has now outperformed HY Bonds in seven of the past eight months.^1,3 Senior secured loans remain one of the few fixed income investments generating positive returns in 2018. For perspective, the Bloomberg Barclays U.S. Aggregate Bond Index (the Barclays Agg) returned 0.71% in May, benefiting from a decline in U.S. Treasury yields, but remains negative in 2018 due in part to the index’s higher sensitivity to rising interest rates.⁴

Treasury yields decline amid flight to quality: The yield on the U.S. 10-year Treasury note declined in May as trade-related and geopolitical concerns precipitated a flight to quality among investors. By month’s end, U.S. 10-year Treasury yields were approximately 2.86%, compared to a high of 3.11% in mid-May.⁵ The decline in yields (and concurrent rise in prices) in the last half of May contributed to the generally strong performance of the Barclays Agg, which benefited from its relatively high allocation to U.S. Treasuries and other higher-duration investments. May, however, was more the exception than the rule in a year that has seen U.S. Treasury yields trend higher. As a result, higher-duration investments have generally underperformed in 2018. For example, higher-duration BB bonds have generated year-to-date returns of -1.79%, while lower-duration CCC bonds have generated year-to-date returns of 2.67%.⁶ More broadly, both the high yield bond and senior secured loan asset classes have outperformed the higher-duration Barclays Agg. Senior secured loans, which have floating rate coupons, have particularly benefited from the rise in interest rates seen through the first half of 2018.

Key takeaway

Interest rate sensitivity drove returns during the month as higher-duration assets tended to outperform as 10-year Treasury rates fell.