How Falling Interest Rates, Better Fundamentals May Support U.S. High Yield
The U.S. economy may slow this year and interest rates may fall, making high yield bonds a potentially attractive investment. Learn why.
- Fixed Income Insights
- Volatility & Risk
- High Yield
- Market & Investment Trends
Key Points
What it is
We explain why U.S. high yield bonds appear an attractive investment now.
Why it matters
U.S. economic uncertainty could spark volatility in the equity market, increasing the importance of diversification.
Where it's going
With attractive yields and the potential for price appreciation, high yield bonds may help investors manage portfolio risk.
With the potential for a U.S. economic slowdown, we think investors face economic uncertainty. Further, lower interest rates likely will accompany expected rate cuts by the Federal Reserve. In such a scenario, we think one investment worth considering is high yield bonds. Let’s take a closer look.
The landscape of high yield bonds has undergone significant changes, marked by notable improvements in credit quality. BB- and B- issuers currently comprise a substantial portion of this asset class, reflecting an increase from the 20-year average. This shift signifies a more resilient and diversified pool of issuers, better positioned to navigate economic challenges. Stringent lending standards and higher interest rates also help restrain excessive debt accumulation and stabilize default risk. As a result, we expect to remain relatively stable around the long-term average of 3% to 4%.
The rise in interest rates over the past two years have led to a decline in high yield , setting the stage this year for potential price appreciation if rates were to fall in the near future. Anticipated Federal Reserve rate cuts further contribute to the optimism surrounding high yield bonds, and today’s elevated yields enhance returns and are historically aligned with robust future performance. Analysis dating back to 2000 suggest that high yield bonds with yields of 7% to 8%, which mirror current levels, have delivered promising returns a year later in most cases. These findings underscore the potential for high-yield bonds to represent the sweet spot for investors in the current market environment.
We think the expectations of Federal Reserve rate cuts and improved fundamentals will continue to support . Also, a benign default outlook provides an attractive backdrop for elevated yields. In light of these factors, investors may find adding high-yield bonds to their portfolios beneficial, especially for diversification and risk management considerations during periods of equity market volatility.
Credit ratings are scores created by ratings’ companies such as Moody’s, S&P, and Fitch that represent their judgments of companies’ abilities to repay their debts.
The default rate is the percentage of bond market assets represented by issuers who have stopped making debt payments and are declared in default by bondholders.
Bond prices fluctuate inversely with changes in yields. Normally, when bond prices fall, their yields rise. When bond prices rise, their yields fall.
Main Point
High Yield Bonds for Managing Risk
With the potential for a U.S. economic slowdown, we think investors face economic uncertainty that could spark volatility in the equity market. To potentially soften equity volatility, we think investors could consider allocating to high yield bonds, which may provide resilience because of improved fundamentals.
Why High Yield Bonds Could Benefit Portfolios in 2024
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