Marktkommentar I High Yield Monthly Update

High Yield Update – Views from our High Yield investment boutique, NCRAM

Published November 1, 2021

David Crall, CEO and CIO, Nomura Corporate Research and Asset Management Inc.

US High Yield

The US high yield market declined -0.19% in October, bringing the YTD return to 4.49%, as measured by the ICE BofA US High Yield Constrained Index (HUC0). Spreads were flat on the month, with HUC0’s option-adjusted spread rising 1 bp to 317. The market’s decline was mainly driven by rising US Treasury yields. The 10-year US government bond posted its third consecutive negative monthly return, declining to -4.51% YTD, while the yield rose to 1.56% after peaking at almost 1.70% intra-month. There was limited differentiation in high yield returns by ratings category in October, with BB-rated bonds returning -0.21%, Bs down -0.15%, and CCCs falling -0.39%.

The high yield market largely managed to tread water in October, despite ongoing macroeconomic challenges. Third quarter earnings have been strong; only 9% of high yield issuers reporting thus far have surprised to the downside. New issue volume cooled to $29.3 billion in October, below the monthly average of $46 billion seen in first three quarters of the year. Issuance continues to track closely to last year’s record volume, and the elevated percentage of high yield bonds currently trading above their next call price portends a heavy new issue calendar in 2022. The reopening trade regained momentum in October, with top performing sectors counting Energy, Autos, and Transportation. Underperformers included the Media, Telecom, and Technology sectors that tend to thrive when Covid anxiety rises.

The key driver behind rising interest rates has been concern about mounting inflationary pressure. Market participants are looking beyond the disappointing 3Q21 US GDP print (2.0% annualized) toward a resumption of above-trend growth as the impact of the troublesome Covid delta variant dissipates. Supply chain disruptions show no signs of abating in the near term. Executives from Toyota, Ford, and GM all see microchip shortages persisting well into the second half of 2022. The queue of transport ships at port waiting to unload remains lengthy. Although the Port of Los Angeles recently shifted to 24-hour operations, a dearth of truckers will impact the effort to get idled containers on the road. Retailers are increasingly worried that goods in transit today will not arrive on shelves prior to the holidays. Most alarming is emerging evidence of a wage-price spiral in the US economy. Workers, emboldened by the absence of slack in the labor market, are agitating for higher wages – see the ongoing John Deere strike. Individual workers are also motivated to seek better pay and working conditions, as demonstrated by the quit rate in the US rising to a 20-year high. The Employment Cost Index jumped a lofty 1.3% q/q in 3Q21, and wages and salaries rose to the highest annual rate since 1982. Over the last six months, the Fed’s favored Personal Consumption Expenditures inflation indicator is up 5.6% annualized.

NCRAM remains cautiously optimistic about the outlook for high yield as we approach year-end. Earnings are strong, more rising stars are making a compelling case for an upgrade to investment grade (JP Morgan expects $277 billion of high yield to migrate to investment grade in 2022), and market seasonals are typically supportive in the fourth quarter. We expect the Fed to take its foot off the accelerator and announce a tapering of its asset purchase program in November. A taper running from November to mid-2022 is priced into the market, but the bigger question is the timing and quantum of the Fed’s interest rate liftoff. The Fed Funds Futures market implies two rate hikes in 2022 after the taper concludes, which would likely trigger an orderly rise in yields across the Treasury curve next year. A more aggressive tightening campaign could prompt questions regarding a monetary policy-driven growth slowdown, while a more dovish approach may raise concerns that the Fed’s complacency is planting the seeds for persistent inflation in coming years.


Global High Yield

European high yield was soft in October, returning -0.64% during the month (local currency terms), as measured by the ICE BofA European Currency High Yield Constrained Index (HPC0). While the market finished off the lows of the month, investors encountered several headwinds. Concern about central bank policy in the face of stubborn inflation data continued to be a theme. The Fed appears likely to begin its asset purchase taper in November, and though the ECB continues to tell a dovish story, markets are testing its resolve. In this environment, the rise in interest rates that began in September continued, with the 10 yr Bund yield rising from -0.20% to a high of -0.09% mid-month. The yield was -0.44% at the beginning of September. This rise in interest rates has been an impediment for credit assets in Europe. At the same time, though the European economy has continued its recovery, investors are becoming increasingly concerned that we may have already seen peak growth in the face of potentially tightening monetary policy. Furthermore, inflation and supply chain concerns have led to some uncertainty around 3Q21 earnings for specific industries and companies. The market continues to take down historic new issue volume, with many new names coming to market for the first time. While the primary issuance supply has generally been absorbed, it has weighed on the secondary market. We expect the pace of European new issues to slow somewhat, but to remain relatively heightened as we head into year-end. Finally, while the problems in the Chinese property sector are not directly related to European credit, slower growth in China is a headwind for European exporters. In October, BBs outperformed while CCCs lagged in the risk-off environment.

Emerging market (EM) hard currency sovereign bonds, as measured by the JP Morgan Emerging Markets Bond Index Global (EMBIG), posted a relatively flat return in October (0.06% MTD, -1.47% YTD). US Treasury volatility and concerns regarding Fed policy were key market drivers on the month. High yield credits underperformed with a -0.26% decline and 8 bps of spread widening, while investment grade credits performed marginally better (0.28% return and only 3 bps of spread widening). Emerging market high yield corporate bonds, as measured by the ICE BofA High Yield US Emerging Markets Corporate Plus Index (EMUH), declined -2.47% in October (-3.87% YTD). The weakness was driven primarily by continued fallout in China’s property sector. Asian high yield bonds declined a jarring -7.59% on the month. An unexpected default by a property credit and uncertainly regarding Evergrande’s debt restructuring accelerated the sell-off. Price declines in the Chinese property sector hit high-beta credits with near-term maturities the hardest, dropping bond valuations below potential recovery value in many cases. Aside from Asia, US Treasury volatility and political noise weighed on some Brazilian corporates.


NCRAM Business

NCRAM ended the month with AUM of $31.5 billion. In Europe, shareholders approved our proposal to convert the Nomura Funds Ireland Global High Yield Bond Fund to the Global Sustainable High Yield Bond Fund. The amendments to the portfolio’s guidelines are designed to bring the fund into compliance with Article 9 of the EU’s Sustainable Finance Disclosure Regulation (SFDR). The fund has adopted a dual investment objective, aiming to deliver strong investment returns and attractive yields, and contribute to positive sustainability outcomes.


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