ICE Fixed Income Monthly

During a year when markets were stalked by uncertainty, it’s been interesting to see some riskier bonds outperform their investment grade counterparts. While many point to reasons for caution, a closer examination of the high yield bond segment may instead provide broader cause for optimism.

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First, a few relevant stats. High yield corporate bonds have returned 4.68% for the year through to October, according to the ICE BofA US High Yield Index, versus a 1.38% loss for investment grade bonds as represented by the ICE BofA US Corporate Index over the same period.

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Key metrics within the high yield space are heartening. Twelve-month trailing high yield defaults stand at 3.1%, a contrast to nearly 8% in 2021, after peaking at 9% in August 2020. The recent upgrade of Ford Motors from high yield to investment grade, for the first time since March 2020, is also somewhat of a bellwether: rising stars (companies obtaining credit upgrades) have outpaced fallen angels (companies receiving credit downgrades) this year by more than 6-to-1 in the U.S. market at $140.9 billion versus just $21.9 billion, respectively.

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A high-rate backdrop has piqued some concern about refinancing needs. Yet 0-18 month near-term financing for the U.S. high yield segment sits at ~5%, in-line with average figures over the last 12 years. In other words, companies knew the era of low rates would end, and there is no looming maturity wall with higher borrowing costs on the foreseeable horizon.

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Basic supply-demand dynamics are also favorable. Back in 2021, high yield bond issuance stood at over $400 billion as companies rushed to refinance amid a low-rate backdrop. Now, with rates at their highest level in decades, high yield issuance sits at just ~$150 billion for 2023 and is expected to reach ~$170 billion by year end. A dynamic of low supply and steady demand is supported by investment mandates from vehicles like pension funds, insurers, and trading in the secondary market.

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Of course, all performance is relative. For the investment grade segment, losses for the year through to October were due in large part to banks, which suffered amid fallout from the regional banking crisis and subsequent credit downgrades. Alongside this, the continuation of an aggressive rate hike cycle saw a dichotomy where investors either flocked to the (perceived) safety of Treasuries with decent yield – or sought far richer returns in high yield bonds.

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All in, while it would be na?ve to dismiss lingering risks to growth, the recent uptick in market sentiment is well-supported by indicators in the high yield debt market. And as the holiday season kicks off, it’s a reprieve for which market participants can be grateful.

Read more in ICE’s Fixed Income Monthly: https://www.ice.com/fixed-income-data-services/fixed-income/ice-fixed-income-monthly-report