Still 'hmm' on high yield Still 'hmm' on high yield http://www.federatedinvestors.com/mmdt/static/images/mmdt/mmdt-logo-amp.png http://www.federatedinvestors.com/mmdt/daf\images\insights\article\question-mark-gears-small.jpg September 8 2020 August 6 2020

Still 'hmm' on high yield

Liquidity is abundant but fundamentals remain iffy.

Published August 6 2020

An extremely strong technical environment continues to overwhelm the fundamentals in the high-yield market, creating opportunities amid lingering concerns. On the technical side, global fiscal and monetary policies are ultra-supportive and are likely to stay that way for some time. Combined with the lack of yield across the global fixed-income universe, this is making U.S. high-yield bonds one of the best games in town.   

Yet the fundamentals are an entirely different story. While third- and fourth-quarter GDP growth is almost certain to improve dramatically off the second-quarter’s worst quarterly reading for the metric since its formation in the late 1940s, the actual results nonetheless are certain to be much worse than the readings for the same period in 2019. At this juncture, it’s highly questionable if the economy will recover to its 2019 peak in GDP until the end of 2021—if then. In addition, the employment picture continues to be grim although, like the economy, improving from earlier historic weakness.

So while the bulls say things are improving, the bears counter that employment and GDP remain weak. From a financial markets’ perspective, the bulls are winning so far—except when viewed in the context of a 10-year U.S. Treasury yield that is hovering around 50 basis points. This rapid improvement in markets against weak fundamentals has kept our fixed-income sector allocation committee from returning to an overweight position in high yield during this recent rally, as we think a better opportunity could come after we move through another period of weak earnings in the third quarter

By then, we believe the worst of the default rates should be behind us—assuming the virus doesn’t flare up again in the fall—as the economy slowly claws its way back. In the meantime, default rates continue higher led by the Energy and Retail sectors. With that said, there are opportunities to be found by being selective in Energy-related “fallen angels”—those formerly investment-grade securities that sold off dramatically amid earlier oil-price volatility. If the virus does intensify and the recovery flattens, we may start to see industries in the Consumer Discretionary sector pressured, particularly leisure and hospitality.

Tags Fixed Income . Markets/Economy . Interest Rates . Coronavirus .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond credit ratings measure the risk that a security will default. Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings of BB and below are lower-rated securities; and credit ratings of CCC or below have high default risk.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.

Federated Investment Management Company

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