Marktkommentar I High Yield Monthly Update
High Yield Update – Views from our High Yield investment boutique, NCRAM
June 1, 2023
David Crall, CFA
CEO and CIO, Nomura Corporate Research and Asset Management Inc.
US High Yield
The US high yield market returned -0.95% in May, dropping high yield’s total return to 3.73% YTD, as measured by the ICE BofA US High Yield Constrained Index (HUC0). The 10-year US Treasury yield spiked 40 bps intra-month, driven by concerns that failure by the US Congress to raise the federal debt ceiling could ultimately lead to a default on government bonds. Yields retraced somewhat after Congress and the White House reached an agreement on spending restraint in exchange for the debt ceiling hike. The 10-year yield ended the month up 22 bps at 3.65%. Stubborn inflation data and mixed Fed commentary bolstered the view that the FOMC may not be finished tightening (even though a June hike appears unlikely), adding to the bearish sentiment on rates.
The high yield risk premium increased in May’s volatile macro environment. Spreads widened 16 bps, rising to 471 bps. Regardless of the spread widening, market fundamentals remain relatively strong. High yield issuers’ operating earnings surprised to the upside in 1Q23, with a plurality of companies reporting thus far delivering better-than-expected financial results. More than 30% of issuers guided 2023 earnings expectations higher, vs. about 10% guiding lower. In May, the leisure and retail sectors outpaced the high yield market’s performance, while broadcasting and healthcare lagged. Lighter exposure to interest rates helped CCC-rated bonds outperform, but BBs trailed the market.
Looking forward, all-in yields approaching 9% create an attractive entry point for committing capital to high yield. Continued robust cash flow growth has driven the market’s debt service coverage ratio close to decade-high levels. Furthermore, ongoing rising star upgrades (Occidental Petroleum’s $17bn of debt was upgraded to investment grade in May) and relatively light new issue volume are combining to bolster the market’s supply/demand dynamic in support of high yield bond prices.
European High Yield
The European high yield market was firm in May, with the ICE BofA European Currency High Yield Constrained Index returning 0.84% for the month and 4.22% YTD (EUR, unhedged). The investment environment was supported by generally constructive 1Q23 earnings, positive events such as M&A and asset sales, resilient economic conditions, and indications that inflation has peaked in Europe. Conditions in the US, headlined by the Fed indicating it is close to a pause and progress toward finalizing a debt ceiling deal, also helped the European market. Though rates showed some volatility, German bund yields ended the month slightly lower, as softer-than-expected core inflation in most European countries supported the market. B-rated bonds led the market higher, followed by CCCs, as the lower rated parts of the asset class caught up after lagging the initial recovery from the banking stress in March. Strong technical conditions continued to support the market given light new issuance.
Emerging markets (EM) hard currency sovereign bonds, as measured by the JPMorgan Emerging Markets Bond Index Global (EMBIG), declined -0.89% in May (+1.85% YTD). Debt ceiling concerns and persistent signs of high inflation and strong labor markets in the US drove interest rates higher. Investment grade EM sovereign bonds underperformed, with a -1.25% decline in May on the back of higher US yields. High yield EM sovereigns performed slightly better (-0.35%), with some high-beta credits outperforming, particularly in the EMEA region and Asia. Recent Presidential elections in Turkey and Nigeria raised the prospect of potential changes in economic policy, which if materialized could serve as a positive catalyst lowering risk premia. The EMBIG index ended May with an average yield of 7.85% and spreads about 400 bps over US Treasuries. There is a dichotomy in the market between investment grade credits, where the average yield is 5.34%, and high yield sovereign credits, where yields hover around 12%.
Emerging markets corporates, as measured by the JPMorgan Corporate Emerging Markets Bond Index Broad Diversified (CEMBI BD), outperformed EM sovereigns with a modest -0.58% decline in May (+2.54% YTD). The CEMBI BD index was less impacted by rising US yields, given the shorter duration in the EM corporate bond market. Investment grade credits slightly outperformed high yield names. Renewed weakness in the China property sector was a drag on returns in May, but the index spread widened only marginally in the month, rising to 347 bps.
NCRAM’s Multi-Asset Credit Strategy posted a small gain in May. Our low risk posture, overweight to European high yield, credit selection, and tactical duration management were positive contributors. We view the resolution of the debt ceiling issue as a short-term positive, avoiding a technical default in the US, but as a long-term negative given the prospective fiscal tightening required to strike a deal.
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