This particular headline and accompanying chart (below) has received a huge amount of air-time in recent weeks.
Source: Bloomberg, Bank of America Merrill Lynch, 31 August 1999 to 31 August 2017.Note: Index HE00 used for euro high-yield and yield expressed 'to worst”'call date.
The headline yields are indeed similar and the picture is being used as an example of how bizarre some parts of the bond market feel in the era of central bank asset purchase programmes. This feels a bit like 'fake news' to us, with one glaring flaw in the argument - the comparison ignores the impact of hedging costs, both interest rates and foreign exchange.
For a euro-based investor, the cost of hedging a US-dollar denominated asset back to euro is currently close to 2%, reducing the yield on a 10 year US government bond from around 2% to close to 0%. Conversely, a US-dollar investor would enjoy an increase of around 2% (primarily because of the base interest rate differential between the two markets) when investing in euro denominated assets and hedging back to US dollars, bringing the yield on the euro high yield market up from around 2.5% to around 4.5%.
While the yields available on euro high-yield bonds are certainly lower than they used to be, they are still higher than 10-year US government bonds… when compared correctly. Most of our investors invest in fixed income on a hedged basis, so it makes sense to compare yields on a hedged basis.
Comparing apples with apples
Looking at the headline statistics from the US and euro high yield bond markets shows a yield differential of more than 3%. However, for a euro-based investor, the cost of hedging reduces this pick-up by around 2% and the headlines also hide the fact that the euro market is generally shorter duration with a higher average credit rating and a central bank providing unprecedented levels of support to government and corporate bond investors.
Source: Bloomberg, Bank of America Merrill Lynch, 31 August 2017.
Note: Yield and credit spreads are expressed 'to worst' call date. Indices H0A0 and HE00 used.
In this instance looking at the headline yield tells only half the story. Investors need to look through the headlines, understand the details and make valid comparisons when assessing markets.