This past week made for a bumpy roller coaster ride as inflation fears took center stage. Yet, while major indices were up and down, the high-yield debt market was solid as a rock.
Fixed income investors could be at ease watching inflationary pressures rise, which could prod the Federal Reserve into eventually raising rates. While the Fed has repeatedly stated its desire to not raise rates, much of the market is prepping for just that scenario.
Inflationary fears racked the markets this week, starting on Tuesday when the S&P 500 took a dive. The index is down 1.6% the last five days.
“With the S&P 500 down 1% and all of its sectors in the red, the junk bond market and vehicles tracking that market were seeing only slight declines Tuesday,” a Barron’s article reported.
With an improving economy and prices rising, the prevailing sentiment is that rates will eventually rise. This, in turn, could boost high yield returns and give fixed income investors more to cheer about.
Strong Fundamentals for High-Yield ETFs
During the height of the pandemic, investors wouldn’t touch high-yield with a 10-foot pole. As social distancing measures were forcing businesses to close or alter their day-to-day operations, the riskiest debt was rebuked.
With the economy re-opening amid a global vaccine rollout, investor confidence in high-yield assets is coming back. While yields might be ticking higher, they’re still relatively low.
“The fundamentals for high-yield issuers are quite good,” said John Hollyer, head of fixed income at Vanguard. “We have an economy that’s reopening. We have very strong fiscal policy. We have very supportive monetary policy. That makes a good environment for corporate borrowers.”
Moving forward, Hollyer thinks the higher yields should sustain themselves, at least in the short-term.
“Until inflation is demonstrably above 2% for an extended period like 12 months and employment has neared full employment across many different subsectors of workers, the Fed is going to hold out from tightening,” he said. “Compared to past periods, returns may not be as generous, but there’s good reason to believe that the returns embedded in a 3.5% yield will be earned over those near to intermediate terms.”
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