11 February 2021
A new low
Yields on US high yield have reached a new all-time low, despite weak corporate fundamentals. But the strength of the macroeconomic backdrop, combined with the powerful search for yield, suggests it’s not time to take profit yet.
High yield-rated companies continue to face fundamental challenges, with revenues depressed and leverage elevated. However, corporate health appears to have bottomed: the credit cycle is shifting to the repair phase; downgrades from investment grade to high yield peaked in 2020; and default rates are expected to fall from 6% currently to 3-4% by year end. Recent developments in the macroeconomic backdrop are also increasingly supportive, though from an already-constructive starting point. In particular, the US fiscal stimulus package has been upsized from initial expectations of around USD 1 trillion to USD 1.5 trillion or higher as the Biden administration takes the route of budget reconciliation, which is less reliant on bipartisan support, to obtain approval for the government spending. Additional fiscal stimulus will help to drive economic growth, ultimately benefiting high yield-rated companies.
A new record was set in the US high yield (HY) market on 9 February, when the yield hit an all-time low of 4.00%. This level is partly driven by the low interest rate environment, as spreads are still 43 basis points (bps) above five-year tights. At 359 bps, current US HY spreads may not present obvious value, but do offer scope to absorb a gradual move higher in interest rates. Looking under the surface of the overall market, an important dynamic to monitor in the single B space is the increasing lack of dispersion. Currently, 79% of single B-rated issuers trade within a 150 bps range of the index level, compared to about 20% in March 2020. With names trading tighter in unison, it is even more crucial to do the homework and identify those that could be at risk of a correction. (All data as of 9 February).
Increasing lack of dispersion across issuers makes it crucial to identify those at risk of correction
US HY fund flows have been under pressure recently, with almost USD 800 million of outflows year to date as investors have favoured the floating rate characteristics of the loan market. Further challenging the technical picture is the heavy supply: January was the second-largest month in history for US HY gross issuance, at USD 56 billion. Nevertheless, the overwhelming technical factor continues to be the substantial liquidity in the system, which leaves investors with limited alternatives for sourcing yield. (Data as of 9 February).
What does this mean for fixed income investors?
With yields at all-time lows, it’s difficult to assert that US high yield offers compelling valuations. However, current spread levels still provide sufficient carry to generate positive total returns in the event of a benign move higher in rates. Combined with the encouraging direction of travel for the fundamental backdrop, in terms of both corporate health and overall monetary and fiscal policy, we think it makes sense to stay the course.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum