The Bottom Line
- High Yield (HY) bonds have gotten the attention of investors in recent weeks, thanks to a rapid rise of HY spreads – that is, the difference in average yields between HY and similar investment-grade bonds.
- HY spreads can sometimes “blow out” as issuers’ ability to pay deteriorates due to a recession. So the key question is whether this signals a looming problem in general business conditions – or something more benign.
- What’s important to realize is that when considered relative to HY spreads over the past year, current levels aren’t the anomaly; it’s the rest of the year that’s been unusual.
- The tightening of spreads at the start of 2017 looks more to do with the post-election hopefulness about improving business conditions.
- Indeed, that optimism, which has continued all year, has had a positive impact on perceived creditworthiness at all rating levels. Investment-grade spreads also headed downward for much of the year.
- In fact, the upward moves in both spreads suggests that the explanation for the rise might lie elsewhere. Possibilities include doubts about the outcome of U.S. tax legislation; a surge in issuance of corporate debt in advance of a widely expected rate hike by the Fed in December, driving bond prices down and bringing yields up; and differentiation with in the HY market, as buyers took advantage of new issuance to upgrade the credit profiles of their bond portfolios.
- With an average coupon of 6.4%1 vs 3.9% for U.S. Corporates, the attractiveness of HY is clearly strong.
- In the hands of a discerning active bond manager, able to perform the credit analysis needed to separate the mispriced from the rest in the category, High Yield may clearly be worthy of consideration – especially for income-oriented investors.
1 Source: Bloomberg, Nov 21, 2017
