Global high yield: Will the good times last?

The following blog is an extract from our latest Active Fixed Income Outlook.

The past: what just happened?

Despite fears of recession abating, investors were caught somewhat off guard by the dovish pivot from the US Federal Reserve (Fed). The statement from Fed Chair Jay Powell reinforced his intention to halt aggressive rate tightening, given firm evidence that inflation was on a declining trend, and despite tight labour markets. High yield markets were weaker toward the end of last year, although November and December saw two strong return months, helped by a return to a more risk-on environment.

The US economy continued to surprise with growth, though the third quarter was dominated by market expectations of the Fed starting to cut rates and debate on what speed. In this environment, high yield markets have continued to perform strongly with strong returns over the summer months.

The present: moving away from recession fears

The strategy continues to target a higher income than the comparative benchmark, expressed through an overweight position in higher spread global names. Our view remains that spreads adequately compensate for the degree of credit risk undertaken (see outlook).

From a regional perspective, we have started to reduce exposure in Europe, rotating back into the US, with emerging markets constituting our largest overweight position. From a sector perspective, our focus on the ‘core’ part of the economy remains, with an overweight exposure to the consumer, services and industrial sectors. Conversely, we have underweight positions in the global automotive, utilities and shipping sectors.

Outlook

As we move into a rate cutting cycle, we believe this will be supportive for the consumer and the economy – both for the US and globally.

Earnings for companies have been going well and we think they are unlikely to fall as much as expected. In this environment we expect the default rate by issuer to continue to remain low. There shall doubtless be a focus on the US presidential election in the near term, where the result could have important implications for fiscal policy, inflation and bond yields. Though with clarity after a number of elections globally and interest rates being cut around the world, we think there will be a pickup in M&A, creating potential income opportunities for the high yield investor.

The above blog is an extract from our latest Active Fixed Income Outlook.