Corporate credit prices rose this week alongside a record high for U.S. equities and generally low new issuance volume following the long holiday weekend.1,2 High yield bond prices continued to move higher as investors weighed a multi-year low for yields against a flattening yield curve and solid corporate earnings.3 High yield bonds returned approximately 0.22% during the week ended June 1 and approximately 0.89% in May – the asset class’s second consecutive month of positive returns.4 Year to date, high yield bonds are now providing returns of approximately 4.9%, with CCC rated bonds outperforming both the B and BB rated categories.4,5,6,7 The global search for yield continued to drive bond yields lower in May, with high yield bond yields slipping to approximately 5.5%.8 For perspective, that is the tightest level since the summer of 2014 when yields narrowed to a historical low of 4.9%.8 Nevertheless, the asset class continued to benefit from strong investor demand, with high yield bond mutual funds recording an inflow of $521 million for the week ended May 31.9 Despite benefiting from similarly favorable supply and demand dynamics, senior secured loans generated more modest returns in May. Returning 0.35% last month, senior secured loans are now providing a year-to-date return of approximately 2.1%.10
U.S. Treasury yields remained anchored this week against the backdrop of weaker inflation data and growing expectations that the U.S. Federal Reserve might move more slowly to raise rates in the second half of the year.11 Although investors widely expect the Fed to raise short-term rates at its June 13–14 policy-setting meeting, softer inflation data has clouded the outlook for the remainder of 2017.12 This week’s economic calendar included the closely watched personal consumption expenditures (PCE) index and May nonfarm payrolls, both of which disappointed to the downside. While consumers increased their spending in April at the fastest pace in four months, prices excluding food and energy were up just 1.57% year over year in what was the weakest reading since the end of 2015.13 The Fed indicated at its May 2–3 meeting that it was prepared to look past a recent softening in inflation data.14 Since then, however, its preferred inflation gauge has eased further, prompting investor expectations for subsequent rate hikes to decline accordingly.15
Flat wage growth
While the unemployment rate in May fell to the lowest level in 16 years, bond investors instead focused on a slowdown in the pace of hiring and relatively flat wage growth. Employers added 138,000 new jobs in May against expectations of 184,000, which helped bring the total unemployment rate to 4.3%.16 Average hourly earnings rose by 2.5% year over year, against expectations of 2.6%, as the data continues to defy expectations of an uptick in wage inflation.17 The report sent the yield on the 10-year U.S. Treasury note to its lowest level since November 10, erasing nearly all the rise since the U.S. presidential election, and the yield on the 30-year U.S. Treasury bond to its lowest level since November 15.11,18 Following the move, the U.S. Treasury yield curve is now the flattest it has been since early October.19
Chart of the week: Soft inflation data casts doubt on Fed trajectory
- This week produced another batch of relatively firm economic data. The pace of hiring in the U.S. slowed in May, yet the economy produced 138,000 jobs and the unemployment rate declined to 4.3%, a 16-year low.17 Meanwhile, consumer spending in April bounced from the relatively weak readings of the first three months of 2017.13
- The consumer spending figures seemed to confirm the FOMC’s belief that the weakness in first-quarter economic growth was likely due to “transitory factors” and firmed up investor expectations that the FOMC will raise interest rates at its mid-June meeting.20
- At the same time, however, inflation has shown signs of moderating recently. Personal consumption expenditures, the Fed’s preferred measure of inflation, declined in April and, on a year-over-year basis, fell further below the 2% mark.13
- In a speech on Tuesday, Fed Governor Lael Brainard noted that persistently soft inflation data could cause her to “reassess the appropriate path of policy.”21
- Investors recently also appear to be questioning whether the Fed might alter its policy path and stop at two rate hikes in 2017.15 The market-implied probability of the FOMC enacting three rate hikes this year has declined from a peak of nearly 50% on May 10 to only approximately 36% this week.15
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 S&P Leveraged Commentary and Data.
3 Thomson Reuters, http://bit.ly/2rjDFCy.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Bank of America Merrill Lynch U.S. High Yield CCC Rated Index.
6 Bank of America Merrill Lynch U.S. High Yield B Rated Index.
7 Bank of America Merrill Lynch U.S. High Yield BB Rated Index.
8 Bank of America Merrill Lynch U.S. High Yield Master II Index (yield-to-worst).
9 Thomson Reuters Lipper.
10 Credit Suisse Leveraged Loan Index.
11 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
12 The Wall Street Journal, http://on.wsj.com/2rMzReo.
13 U.S. Department of Commerce, http://bit.ly/1cR0IcA.
14 Federal Reserve, http://bit.ly/2ph7vEa.
15 Bloomberg, based on CME data.
16 The Wall Street Journal, http://on.wsj.com/2s1FhBU.
17 U.S. Department of Labor, http://bit.ly/2iYbHWM.
18 Federal Reserve Bank of St. Louis, http://bit.ly/29ecFfc.
19 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
20 Federal Reserve, http://bit.ly/2qGwxBe.
21 Federal Reserve, http://bit.ly/2qFPpfY
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