Tom Ross, corporate credit manager, discusses conditions in the high yield market, including the default outlook, the importance of monetary and fiscal stimulus and whether high yield can tolerate inflation.

  Key takeaways

  • Credit spreads are wider in high yield than at the start of the year, reflecting expectations of higher defaults, albeit a default rate that is less severe than the market feared back in March.
  • Monetary policy is having a positive triple impact on high yield through direct support from corporate bond purchases by central banks, the provision of ample liquidity allowing companies to refinance, and low interest rates amplifying the grab for yield.
  • A potential uptick in inflation is less of a concern for high yield as their credit spreads offer some cushion against rising government bond yields, while rising prices can be good for corporate revenues.

Notes

Returns: The return on the ICE Global High Yield Bond Total Return Index was -0.3% in the first nine months of 2020. Source: Bloomberg, 31 December 2019 to 30 September 2020, in USD. Past performance is not a guide to future performance.

Credit spread: The difference in yield of a corporate bond over a government bond of the same maturity. The spread to worst for the ICE Global High Yield Bond Total Return Index was 558 basis points at 30 September 2020, up from 382 basis points at 31 December 2019 (Source: Bloomberg, 30 September 2020). If a bond has special features, such as a call (ie, the issuer can call the bond back at a date specified in advance), the yield to worst is the lowest yield the bond can achieve provided the issuer does not default.

Consumer confidence: For example, US consumer confidence as measured by the Conference Board Consumer Confidence Index fell to a low in 2020 of 85.7 in April 2020, this compares with a low of 25.3 in April 2009 (the low during the Global Financial Crisis). The April 2020 consumer confidence figure was higher than any of the crisis lows of the last fifty years. Source: Refinitiv Datastream, Conference Board Consumer Confidence Index, 30 September 2020.

Inflation: Using the US as a global proxy, we can compare US high yield bonds, US investment grade corporate bonds and US Treasury bonds to show periods where inflation rose from a low point to a high point and the total returns of these three bond markets during the period. High yield performs the strongest in total and ranks first (shaded green) over the most periods.

US Inflation rate and total returns of US bond indices during periods of rising inflation

Period of rising inflation from low to high point Inflation low % Inflation high % High yield % Investment grade % US Treasuries %
31/05/1994 - 31/12/1996 2.29 3.32 37.1 26.9 22.2
31/03/1998 - 30/06/2000 1.38 3.73 1.5 7.3 11.4
30/06/2002 - 31/03/2003 1.07 3.02 11.1 10.8 8.8
28/02/2004 - 30/06/2006 1.69 4.32 15.7 3.6 3.0
31/08/2007 - 31/08/2008 1.97 5.37 -1.4 1.5 8.6
31/10/2009 - 30/09/2011 -0.18 3.87 18.0 16.1 13.7
31/10/2015 - 31/07/2018 0.17 2.95 21.7 8.9 1.4

Source: Refinitiv Datastream, 31 December 1993 to 30 September 2020, US All Urban Consumer Price Index annual inflation rate, total return in US dollars of ICE BofA US High Yield Index, ICE BofA US Corporate Index, ICE BofA US Treasury Index. Past performance is not a guide to future performance.