High yield has more to give High yield has more to give http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\milky-way-man-small.jpg February 1 2022 January 20 2022

High yield has more to give

Ratings upgrades and rebounding economy create favorable backdrop.

Published January 20 2022
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The high-yield market ended 2021 on a high note, with a very strong December lifting the benchmark1 return for the year to 5.26%. This came in a year when the yield on a 5-year U.S. Treasury went from 0.36% to 1.26%, once again proving the resiliency of high yield in a rising-rate environment. 

So, what about this year? Obviously, it’s been a bit of a rough start from a total return standpoint. Equity and government bond prices have fallen, dragging high yield along with them. For the year, however, we believe 2022 will resemble 2021 with modest absolute returns and good excess returns versus other fixed-income assets. Treasury rates should go up and we believe spreads—the yield differential relative to comparable maturity Treasuries—still have room to marginally tighten. We expect extremely strong corporate credit conditions, with a big assist from a strong economic environment, to drive performance and for upgrades to again outpace downgrades. 

For the high-yield market, most of the action in 2021 revolved around very strong corporate credit conditions. Credit rating agencies upgraded far more debt than they downgraded. However, in 2021, most of these upgrades were within the high-yield market. While this will continue in 2022, it may be overwhelmed by upgrades from high yield to investment grade—estimates suggest 10% to 15% of the high-yield market could move to investment grade. The real impact may be technical as high-yield holders will need to recycle that money back into high-yield bonds, providing a strong bid to the market. 

I would note that this mixed dynamic within high yield (that is, low-spread bonds exiting the benchmark) may make it look as if spreads are widening and that we are playing loose with the numbers when we talk spreads moving tighter this year. That’s because the loss of the highest-quality, tightest-spread high-yield credits to investment grade could make it appear that spreads are widening in the remaining high-yield universe, but this may just be an issue of mix within the high-yield market. In any case, this doesn’t change the constructive macro backdrop we expect for this year. Default rates, which ended 2021 below 0.5%, should be very low again in 2022. Estimates range from 0.75% to 2.0% versus long-term averages of 3.56%. I would put my money on the low end. 

1 Bloomberg US Corporate High Yield 2% Issuer Capped Index

Tags 2022 Outlook . Fixed Income . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Bloomberg US Corporate High Yield 2% Issuer Capped Index: The 2% Issuer Cap component of the US Corporate High Yield Bond Index. Bloomberg US Corporate High Yield Bond Index is an unmanaged index which measures the USD-denominated, high yield, fixed-rate corporate bond market. The index follows the same rules as the uncapped version, but limits the exposure of each issuer to 2% of the total market value and redistributes any excess market value index wide on a pro rata basis. The index was created in 2002, with history backfilled to January 1, 1993. Indexes are unmanaged and investments cannot be made in an index.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings BB and below are lower-rated securities ("junk bonds"); and credit ratings of CCC or below have high default risk.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.

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