Corporate credit remained largely stable this week, with longer-duration assets feeling some negative effects of a rising yield curve in the wake of the U.S. election. Performance diverged somewhat across both credit quality and industries as investors considered the possible implications of a Donald Trump presidency combined with a Republican-led Congress. Investment grade corporate bonds once again underperformed as longer-dated U.S. Treasury bond yields climbed to near one-year highs amid rising inflation expectations. Investment grade bonds declined more than 1.5% in the week ended November 10, with investors continuing to eschew longer-duration investments in favor of those whose values are less affected by shifting interest rate expectations.1 High yield bonds fared better, declining 0.15% during the week ended November 10, with industries expected to benefit under the new administration outperforming the broader market.2 Notably, the metals and mining sector outperformed all others, with high yield metals and mining bonds providing returns of nearly 1.8% during the week ended November 10.3 The high yield bonds of financial and energy companies were also modestly positive this week, while the high yield bonds of healthcare companies generated returns of approximately -2.7%.4,5 Against the backdrop of this week’s spike in U.S. Treasury yields, floating rate senior secured loans moved slightly higher, generating a modest 0.05% return during the week ended November 10.6 Similar to the high yield bond market, senior secured loan performance varied across industries, with the metals and mining and financials sectors both outperforming the broader index, while the healthcare and shipping sectors were both notable decliners.7
Following Donald Trump’s surprise victory, investors spent the rest of the week assessing which investments might benefit and which might suffer under a Trump administration. Markets, which had largely factored in a Clinton win, were caught wrong-footed Tuesday night as returns initially turned in Trump’s favor. S&P 500 futures declined by as much as 5% in pre-market trading, while the CBOE Volatility Index shot up over 24%.8,9 U.S. equities would later come all the way back as investors reassessed the potential effects of Trump’s policies across corporate sectors and the U.S. economy as a whole.10 While much of Trump’s agenda remains unclear, the president-elect has promised a boost in spending on defense and infrastructure, while also pledging to lower both individual and corporate tax rates.11 While this may expand the budget deficit, it could also have a stimulative effect on the U.S. economy. Trump has also pledged to curb business regulations, a potential benefit to mining and energy companies, financials and small U.S. businesses generally.11 He has said he plans to “repeal and replace” the Affordable Care Act.11 Though his specific plan remains unclear, Trump’s victory led to an immediate reordering within the healthcare sector, with pharmaceutical and biotech company stocks experiencing gains and hospital shares declining in the days following the election.12
With Republicans holding both the House and the Senate, passage of a fiscal stimulus package has now begun to be priced into the bond markets. Largely overlooking the potential long-term risks to growth from Trump’s more protectionist stance on global trade and tighter immigration, investors have instead focused on the positives to economic growth stemming from greater infrastructure spending and lower taxes. The result is a rise in inflation expectations, higher interest rates and a steeper yield curve.13 This week saw the 30-year U.S. Treasury bond yield rise to near a 52-week high and the 10-year U.S. Treasury note experience its largest one-day jump in over three years.14,15 Despite the prospect of heightened financial market volatility in the weeks ahead, the U.S. Federal Reserve appears to be on track to raise interest rates when it meets next month. On Friday, Federal Reserve Vice Chair Fischer signaled his continued support for raising interest rates.16 Meanwhile, the market-implied odds of a December rate hike have only increased in the days since the U.S. election. While a rate hike appears probable, investors will now be looking to the December 13–14 FOMC policy meeting for further clues about the future path of interest rates. While Fed officials have continued to signal their support for gradual interest-rate hikes, the Fed’s December policy statement will be accompanied by revised economic projections and a “dot plot” charting whether interest-rate expectations have been altered at all by the outcome of this week’s election.17
Chart of the week: Shifting expectations
- Almost immediately following the results of Tuesday’s U.S. elections, investors cheered the anticipated tax, spending and regulatory plans of a Trump White House, bidding the S&P 500 Index up more than 4% for the week ended November 10.18 The initial optimism seemed to center around the $500 billion in infrastructure spending that President-elect Trump has signalled he would spend.19
- Much of investors’ enthusiasm for stocks came at the expense of bonds, as yields on the 10-year Treasury note climbed above 2.0% for the first time since January.18 For the week, 30-year Treasury bonds declined approximately 7.0% while 10-year Treasury notes lost more than 3.0% as investors anticipate that increased government spending may lead to faster economic growth and, ultimately, higher inflation.18
- Inflation expectations had been slowly creeping up in recent months as economic data in the United States and abroad has turned increasingly positive. As the chart highlights, however, the gradual increase in the 5-Year, 5-Year Forward Inflation Expectation Rate, a measure of expected inflation over a five-year period, turned from a gradual increase to nearly a straight line in the wake of Tuesday’s elections; the measure jumped approximately 20 basis points since Friday, November 4.18
- Many investors have grown accustomed to the environment of historically low inflation rates that has prevailed since the global financial crisis. With a new administration set to take over the White House in January, investors now appear to be shifting their expectations.
1 Bank of America Merrill Lynch Corporate Master Index.
2 Bank of America Merrill Lynch High Yield Master II Index.
3 Bank of America Merrill Lynch High Yield Metals and Mining Index.
4 Bank of America Merrill Lynch High Yield Energy Index.
5 Bank of America Merrill Lynch High Yield Healthcare Index.
6 Credit Suisse Leveraged Loan Index.
7 Credit Suisse Leveraged Loan Index (metals and minerals, financials, healthcare and shipping components).
8 The Wall Street Journal, http://on.wsj.com/2fBBGlQ.
9 Reuters, http://reut.rs/2fj1QeJ.
10 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
11 www.donaldjtrump.com, http://bit.ly/2d8JY4v.
12 The Washington Post, http://wapo.st/2ffz5PY.
13 Federal Reserve Bank of St. Louis, http://bit.ly/2eZvbYa.
14 Federal Reserve Bank of St. Louis, http://bit.ly/29ecFfc.
15 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
16 MarketWatch, http://on.mktw.net/2eKaFdz.
17 U.S. Federal Reserve, http://bit.ly/29y0IjN.
19 Bloomberg, http://bloom.bg/2aGjKF1.
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