Going global with high yield: Why high yield is outpacing their investment grade counterparts

August 21, 2023

Claudio Da Gama Rose, BlueBay Institutional Portfolio Manager, Global Leveraged Finance team, discusses why banks are on the mend in Europe and provides key metrics and outlook expectations for the global high yield market.

We continue to like the underlying fundamental strength of the European banking sector, as banks remain well-provisioned and should continue to benefit from the rising rate environment.

European banks on the mend

The Q2 earnings results have signalled to markets that bank earnings are improving and reassured investors that the crisis has subsided. The results follow a tumultuous first quarter in which Silicon Valley Bank and two other lenders failed.

In recent years, European banks have been operating with tight spreads on their loan books but with interest rate rises allowing banks to improve their profitability once again, capital ratios are strong.

Global high yield’s improving metrics

As we are past the halfway stage of the calendar year, it is worth reflecting on some key metrics of the asset class. From a return perspective, Global high yield has returned c. 6% and is bouncing back nicely from last year’s sell-off. While higher-rated corporate and sovereign debt has been the fixed income asset classes in demand, US and European high yield market returns are 3-4% higher than their investment grade corporate equivalents.

From a fundamental perspective, company earnings releases have been better than feared, with high yield credit metrics remaining strong despite tightening credit conditions. This starkly contrasts the private credit and public loan markets, where higher interest costs have been disproportionately negatively impacted. To be clear, we expect high yield defaults to rise from current levels but significantly lower than traditional expectations for a high yield default cycle.

Going global with high yield

Technical factors remain supportive as overall high yield issuance has not accelerated to the same extent as investment grade. However, we do anticipate a slow and steady rise in default rates due to the low level of near-term maturities and the absence of a sizeable problematic sector.

With lending standards set to remain significantly tighter, this is likely to feed into a broader tightening of financial conditions. We remain vigilant around the longer-term effects of tighter credit conditions, which have often been negative for high yield spreads.

For the rest of the summer, we expect global high yield to add to year-to-date total returns incrementally absent a macro shock. High yield bonds benefit from low supply levels and the lack of a problematic sector across European and US high yield markets. In a continued period of lower volatility, high income asset classes like high yield will outperform lower-yielding asset classes.

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