A high-yield pause that refreshed
Brief summer lull didn't derail solid fundamentals.
It was an “interesting” couple of months for the high-yield market. From early July through mid‐August, it struggled a bit at least on a relative basis. Yield spreads—the difference between yields on U.S. Treasuries and comparable maturity high-yield bonds—widened roughly 50 basis points primarily for three reasons: 1) Concerns over the delta variant; 2) A fairly large amount of high-yield issuer supply; and 3) The rally in U.S. Treasury rates. The interesting aspect is none of the widening reflected concerns about corporate credit or the overall economy. Throughout this period, the equity market continued to set new highs.
Our view is this was a “pause that refreshed” and nothing to worry about. Once high-yield issuance decreased in mid‐August, the market snapped back, tightening 35 basis points by the end of that month with pretty good momentum into September. Also, total returns were positive, with the benchmark Bloomberg US Corporate High Yield 2% Issuer Capped Index returning 38 basis points in July and 52 basis points in August. It’s always important to remember that problems in high yield usually relate to credit issues, which tend to be longer term and fundamentally driven. Short-term market underperformance caused by technical factors, supply bubbles, U.S. Treasuries rallying or other temporary disruptions typically self‐correct and reverse, as they did at the end of August.
All indications point to an economy that will remain strong into 2022 and with it, corporate credit quality. Default rates through year-end likewise are poised to stay extremely low—we believe below 1%. And while it’s a little early to predict, we believe default rates next year will remain below average. That’s why Federated Hermes multi-sector strategies are positioned with the goal of a little more yield, a little more credit risk and a little less interest-rate sensitivity and why our fixed-income sector committee continues to recommend an overweight allocation to high yield.