Yields for U.S. corporate high yield debt have dropped while prices have climbed, suggesting that investors are counting on the Federal Reserve to be able to bring down inflation without triggering a recession. Yields on U.S. junk bonds were trading at an average of 8.03% as of Thursday, according to Ice Data Services. That’s down by 84 basis points since the end of 2022, reflecting a sharp increase in prices.
In turn, the gap between yields for high yield corporate debt and U.S. government bonds has narrowed by more than 80 basis points to less than four percentage points. That’s the tightest junk bond spreads over Treasuries have been in 10 months — the gap hasn’t been that narrow since April.
The shrinking spread suggests that investors expect defaults within the $1.8 trillion high yield corporate bond market to be rare. “It also reflects continued bets that the Fed will be able to relax its aggressive tightening of monetary policy sooner than the central bank has indicated — reducing the likelihood of a sharp economic downturn,” according to the Financial Times.
The Fed raised interest rates by 25 basis points (bps) last week as part of its ongoing plan to raise rates to curb high inflation. This rate hike was lower than its previous increase of 50 bps in December and its previous four rate bumps of 75 bps.
For fixed income investors looking to take advantage of this rally in high yield debt while mitigating their downside exposure, the Donoghue Forlines Tactical High Yield ETF (DFHY) is worth looking into.
DFHY seeks to participate in the high yield bond market, which offers generally high coupon rates to potentially provide a high level of current income. It does this by seeking to provide investment results that correspond to the performance of the FCF Tactical High Yield Index.
The fund aims to capture most of the upside and avoid the majority of the downside of the high yield asset class during a full credit market cycle. It uses defensive tactical indicators to mitigate downside volatility and preserve capital by shifting primarily towards intermediate-term Treasury exposure during market declines.
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