State Street acknowledges there are some factors that are supportive of junk bonds this year.
“A number of additional factors support the positive outlook for high yield bonds,” said the firm. “The US economy is likely to grow 2.5% this year, corporate profits are rising albeit at a slower pace, the Fed is taking a pause from interest rate hikes, inflation expectations are modest, high yield supply is shrinking and default rates remain low relative to their long-term history. What’s not to like?”
Still, there are other issues junk bonds need to contend with, including slowing economic growth.
“Both US economic growth and earnings are decelerating. High yield spreads relative to Treasuries widened last year but remain well below long-term historical averages,” said State Street. “This means the compensation investors receive for taking credit risk is still way below historical norms. And although supply is shrinking, high yield bond issuance has exploded in the post-global financial crisis environment of low rates. As a result, even marginally tighter monetary policy, slowing growth and earnings may have outsized negative impacts on default rates and spreads.”
For more trends in fixed income, visit the Fixed Income Channel.