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23 Jan 2025
3 min read

Global high yield: Will this be a Goldilocks year?

As the rate cutting cycle continues, we think investors will look for income which could support high yield.

2025 HY

This article is an extract from our Q1 2025 Active Fixed Income outlook.

As we move in into 2025, we think investors may be able to reap the rewards of structurally lower defaults and a potential regime shift to relatively higher yields.

The past: what just happened?

2024 turned out to be a year where relief as the feared US recession failed to materialise translated into a general sense of positivity and willingness to embrace risk. Risk assets saw very strong returns, with high yield among them. The US economy grew beyond the expectations of most market participants while developed market central banks paused their rate hiking regimes and then saw falling inflation as the catalyst to begin reducing rates. In this environment, high yield markets across all regions and rating segments saw spread tightening of at least 25% and total returns greater than their starting yields. Emerging markets were the clear outperformer, returning more than 10%, followed by the US and Europe which saw around 7% total returns[1].

The present: leaning to emerging markets

We have positioned our portfolios for income in pursuit of yields higher than the benchmark. With resilient US growth, falling interest rates worldwide and low distress ratios, we expect downside risks to be low. We think spreads are unattractive on a historical basis, but in our view prices and yields remain attractive – which has kept demand high.

Our strategy is to position with a preference for emerging markets, in an effort to capture the additional yield on offer while taking advantage of solid corporate and national fundamentals. The portfolios target further spread compression in high and medium-quality securities while being wary of issuers with material default risk whose bond prices we think are becoming over-enthusiastic. In Europe, we retain our underweights to France, Italy and Germany, based on concerns over sovereign debt, the automotive industry and the uncertainty of the political landscape.

From a sector perspective, our focus on the ‘flexible’ part of the economy remains, with an overweight exposure to consumer, services and certain industrial sectors. Conversely, we have underweight positions in the global automotive, utilities and shipping sectors.

Outlook

In our view, global growth looks set to remain in a band that favours high yield credit: not too warm and not too cold, Goldilocks-style. We expect continued central bank cuts to overnight rates as 2025 unfolds, which we think will keep higher-yielding income assets appearing attractive to investors.

Corporate fundamentals appear firm, with high profit margins, moderate leverage and financial policies still relatively defensive. This supports a normalised outlook for defaults and we expect low default rates and low loss rates for high yield bonds.

Downside risks hinge on policy and geopolitical volatility, and the risk that inflation is reignited by government policies and supply chain disruption. We consider these as presently relatively low impacts to high yield fundamentals, and likely to be mostly offset by accumulating income. Upside risks include weak to low growth and falling inflation creating a ‘golden age’ for fixed income, as abundant liquidity and demand for income forces yields and spreads to new tights.

Read our full Q1 2025 Active Fixed Income outlook.

 
[1] Source: ICE BAML Indices as of 13 December 2024.

Active fixed income High Yield
John Ryan

John Ryan

Head of Global High Yield, Active Strategies

John leads the Global High Yield team in Active Strategies with responsibility for $8bn of AUM. John has managed the European High Yield portfolios since 2016 and the Developed Market ESG HY portfolios since 2018. Before this he was a Senior High Yield Analyst covering a range of global industries for more than a decade. John joined LGIM as a Quantitative Analyst in 2005 after graduating from Imperial College, London with a first class honours degree in Mathematics. With this background he developed and built the quantitative tools the team uses for credit research and portfolio construction. John holds the IMC qualification. 

More about John
Sophia Hunt

Sophia Hunt

Fixed Income Investment Specialist

Sophia has worked in the finance industry for over 10 years and is a Fixed Income Investment Specialist covering Global High Yield Portfolios. Prior to…

More about Sophia

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