Amid speculation that the Federal Reserve is at or nearing the end of its interest rate tightening cycle and that the central bank could prove successful in engineering a soft landing for the U.S. economy, there’s optimism that high-yield corporate bonds are poised for upside.
As things stand today, the widely observed Markit iBoxx USD Liquid High Yield Index is higher by nearly 6% year-to-date. This indicates fixed income investors have been rewarded for taking on added credit risk. However, some market observers argue now isn’t the time for investors to overweight high-yield credit.
Market participants looking to exercise that prudence can evaluate exchange traded funds such as the WisdomTree U.S. Short Term Corporate Bond Fund (SFIG). SFIG, which follows the WisdomTree U.S. Short Term Corporate Bond Index, is an investment-grade corporate bond ETF, but it doesn’t cheat investors when it comes to income as highlighted by a 30-day SEC yield of 5.33%. Plus, the WisdomTree fund could prove highly pertinent in the current fixed income environment.
SFIG Matters Today
In theory, the current climate should be hospitable to high-yield bonds. The aforementioned 2023 returns by the Markit iBoxx USD Liquid High Yield Index don’t refute that argument. After all, rate hikes may be coming to an end and recession expectations are being dialed back. However, a deeper view of the current state of affairs highlights the utility of SFIG.
“But in riskier markets, the picture greeting investors in September is more murky. Like August, September also tends to see below average returns and above average volatility, and that seasonality doesn’t turn helpful until mid-October,” noted Andrew Sheets, Global Head of Corporate Credit Research at Morgan Stanley. “Company earnings revisions tend to be weak around this time of year, something our equity strategists believe could repeat. Investors got a lot more optimistic over the summer, raising the hurdle for good news.”
Additionally, there are no guarantees the Fed won’t raise rates again before the end of the year. There are also no promises rate cuts will arrive soon after the calendar turns to 2024. Either scenario underscores SFIG’s muted rate risk, including its effective duration of 2.45 years. That and the ETF’s elevated quality profile could prove beneficial at a time when issuers may be reluctant to market new corporate debt owing to high interest rates.
“A third issue investors will be watching is supply. September is historically one of the heaviest months of the year for corporate bond issuance, but with corporate bond yields now at some of their highest levels in nearly 20 years, will that reduce the incentive for companies to borrow?,” concluded Sheets. “And meanwhile, one of the reasons assigned to the recent rise in US government bond yields has been the high levels of government borrowing. The next few weeks will give a much better idea of the true impact of that potential supply.”
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