The high yield market, as measured by the Bank of America Merrill Lynch High Yield Master II Constrained Index (the “Index”), was down 0.53% for the month of May, as fears of eventual Fed tapering dominated investor sentiment and put upward pressure on Treasury yields. The end result was the most substantial setback in a year for the high yield market. Despite the fears of rising rates, mildly improving economic conditions, healthy corporate earnings/balance sheets, and reduced tail risks and stagnant global growth/low inflation continue to benefit the high yield market.
While there was little question the economy had slowed markedly in March and early April, May’s sharply improved sentiment, initially challenged by the payroll report, was enough to have a material impact on prices across fixed income. For context, Index’ high-yield bond yields had traded between a record low 5.70% and 5.73% between March 15th and April 8th, and took a sharp turn lower to a record low 5.03% by May 7th, 26 basis points (0.26%) of which came in the first 5 sessions of May. Nevertheless, May 3rd’s significant upside surprise for non-farm payrolls was enough to shift investor sentiment from the economy to speculation on eventual Fed tapering. This shift had the effect of sending Treasury yields to their highest level in more than a year.
Despite the selloff in May, we remain constructive on high yield fundamentals, and believe that they are supportive of current market spread and yield levels. The current state of credit fundamentals, alongside a slowly improving economic backdrop, is consistent with our outlook for a low default environment. A modest pace of economic growth, low capital-raising needs, accommodative central banks and monetary policy, and a steady demand recovery in the U.S. are all supportive of profitability for high yield issuers.
High yield bonds are subject to greater price volatility and may be less liquid than higher rated securities; are subject to greater sensitivity to interest rate and economic changes. As interest rates rise, the value of debt securities decreases; whereas prepayment risk tends to occur during periods of declining interest rates. The decline in an issuer’s credit rating can negatively affect the value. International investing involves certain risks and increased volatility not associated with investing solely in the U.S. These risks include currency fluctuations, economic or financial instability, and lack of timely or reliable financial information or unfavorable political or legal developments. These risks are magnified in emerging markets. Distressed securities are speculative.
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The Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market. One cannot invest directly in an index.
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