After yet another record high for inflation, it seems likely that the Federal Reserve (Fed) will hike rates once again. As rates continue to rise, an active approach in the senior loan space could help bond investors capture higher yield potential with limited duration risk, while also managing credit risk.
This article was written with contributions from Mariola Tyranska. Mariola is a Research Analyst on the SPDR Americas Research Team.
Markets Continue on a Rocky Course
Last week, US equities fell across nearly all sectors. Only consumer staples posted a gain, a modest 0.1%.1 The US 2-year yield rose 2 basis points (bps) last week while the US 10-year yield fell 17 bps. This pushed the spread between the two to -20 bps.2 And US inflation reached 9.1% on a year-over-year basis in June. This outpaced the median forecast of 8.8% and registered another 40-year record high.3
Weak Start to Earnings Season
After the first week of earnings reports, just 43% of S&P 500® companies beat on sales and earnings-per-share (EPS).4 This is weaker than the historical post-week-1 average of 47%, and the weakest first week since Q1 2020.5 Earnings season continues this week with releases expected from Johnson & Johnson, AT&T, IBM, Netflix, Tesla, and Twitter.
China’s Economy Slows
China’s economy grew at the slowest pace since the coronavirus outbreak. Economists have further downgraded their 2022 growth forecast, and Goldman Sachs Group Inc. cut their forecast for China from 4% to 3.3%.6
Europe Braces for First Rate Hike in Ten Years
The European Central Bank is expected to raise rates by 25 bps at their meeting this week. This would be the first rate hike in a decade.7 This comes as the US dollar has reached parity with the euro for the first time in 20 years.8
Italy faces uncertainty as Italian President Sergio Mattarella has accepted Prime Minister Mario Draghi’s resignation (his second offer in seven days) after a July 20 vote of no confidence in the Senate. Mattarella has dissolved parliament, paving the way for new national elections in September.
Considering Active Fixed Income as Rates Rise
As June CPI inflation hit 9.1%, the probability of the Fed hiking rates by 100 bps in July jumped to more than 40% — up from 0% just one week ago. This increases the yield potential of senior loans as their floating interest rates will adjust to a higher Fed Funds rate environment.9 But the credit outlook has dimmed, evidenced by a low up-to-downgrade ratio for high yield issuers amid an economic slowdown. This creates more challenges for credit investors.
Aggressive central bank tightening, along with concerns about a sharp economic downshift, may mean that an active approach in the senior loan space could help investors capture higher yield potential with limited duration risk, while also managing credit risk.
The aggressive central bank tightening puts core bonds at a higher risk of duration-induced price declines. The low-duration floating-rate structure of senior loans may help mitigate the impact of rising rates on a bond portfolio. As shown in the chart below, the SPDR® Blackstone Senior Loan ETF (SRLN) has generated income while maintaining a low duration profile, delivering an unmatched yield-per-unit-of-duration ratio.10 SRLN has outperformed the Morningstar Bank Loan category average by 64 bps and its benchmark Markit iBoxx USD Liquid Leveraged Loan Index by 95bps on an annual basis over the last five years.11
Source: SSGA, Bloomberg Finance, L.P., as of July 13, 2022, based on SPDR Americas Research calculations. Past performance is not a reliable indicator of future performance. Treasuries: Bloomberg US Treasury Index, MBS: Bloomberg US MBS Index, Agg: Bloomberg US Aggregate Bond Index, IG Corp: Bloomberg US Corporate Bond Index, High Yield: ICE BofA US High Yield Index. *30-Day SEC Yield used for SRLN’s yield and yield-to-worst (YTW) used for index yields.
SRLN Standard Performance as of June 30, 2022
1 Bloomberg Finance, L.P., as of July 15, 2022. 2 Bloomberg Finance, L.P., as of July 15, 2022. 3 Bloomberg Finance, L.P., as of July 14, 2022. 4 BofAML US Equity Strategy, as of July 18, 2022. 5 BofAML US Equity Strategy, as of July 18, 2022. 6 Bloomberg Finance, L.P., as of July 15, 2022. 7https://www.investing.com/economic-calendar/interest-rate-decision-164 8https://www.cnn.com/2022/07/12/investing/euro-dollar-parity/index.html 9 CME Group, Fedwatch Tool, as of July 14, 2022. 10 State Street Global Advisors, as of July 13, 2022, based on SPDR Americas Research calculations. Yield represents 30-day SEC yield. Past performance is not a reliable indicator of future performance. 11 Morningstar, as of June 30, 2022.
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Investments in Senior Loans are subject to credit risk and general investment risk. Credit risk refers to the possibility that the borrower of a Senior Loan will be unable and/or unwilling to make timely interest payments and/or repay the principal on its obligation. Default in the payment of interest or principal on a Senior Loan will result in a reduction in the value of the Senior Loan and consequently a reduction in the value of the Portfolio’s investments and
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