High yield bonds ended 2024 on…a bit of a high. And it doesn’t seem set to end anytime soon. With economic fundamentals showing slow but steady improvement, led by a surprisingly resilient US economy, we see further scope for positive performance from high yield bonds as we progress into 2025.
Looking at the global market, as illustrated by the ICE BAML Global High Yield Index, yields have come down from their historic peaks, with acceptable averages for high yield considered to be 8-9%.
The crisis-induced peaks we can see in the chart below of 10%+ are few and far between – cumulatively they account for a handful of weeks over the past 14 years.
ICE BAML Global High Yield Index USD Hedged – yield to worst
Source: Bloomberg, Mirabaud Asset Management, ICE BAML, assumes 3 % default rate with 40% recovery. Data as of 31 December 2024.
Today’s average yield is around 7.5%, which we think provides an attractive entry level for investors into high yield. With yields staying at this level, our return scenario analysis suggests a 12-month total return of around 5.3%.
In terms of performance drivers, we think 2025 will be the year of coupon-driven returns. Coupons alone should take us into mid-single-digit performance territory, with the potential to go a little higher with a tailwind of good credit selection and an ongoing benign economic environment in the US.
We think there is also some potential for yields to tighten from today’s levels. If they move to 6%, we would likely enter high single-digit 12-month return territory.
Reflecting its resilient economic backdrop and expected growth of +2%, the US is our preferred regional market for high yield bonds. With average coupons from new issues creeping up to their 10-year high and absolute yield levels still at attractive levels versus just a few years ago, we see continued value in the high yield market, albeit with individual credit selection driving this.
The new issuance market is open, thus lowering the fabled re-financing wall, and with default rates expected to remain low, the asset class is in good shape for another solid year. Spreads are tight but, given the economic backdrop, they could remain tight for some time.
President Trump’s every move is being closely followed and his policies will likely impact the performance of all asset classes, particularly given the risks associated with sticky inflation. Looking at high yield specifically, a Trump growth agenda should be good for the asset class.
Interest rates are another key point for the US market. We expect the Federal Reserve to cut twice this year but this forecast continues to change rapidly given the uncertain direction of inflation and the unknowns that still surround president Trump’s policies. At present, higher for longer is the mantra but that could quickly change if we begin to see deterioration in the economic environment.
We recently adjusted our US exposure to shift towards select higher-yielding issuers in response to economic resilience and reduced recession concerns. An example of an issue we currently hold is the CCC-rated Community Health Systems bond.
The company is an emergency and surgery hospital owner and operator, with 70 hospitals spread across 15 states, giving it a strong geographic reach. We believe the bond pricing does not reflect the potential for debt reduction via asset sales and improving operating metrics as labour costs normalise and inflationary pressures reduce.
In terms of sectors, we think energy is an interesting space to look at in the US, as well as transport. Due to the roll-back of green policies by Trump, environment and sustainability-related sectors and businesses now have a less favourable outlook.
In Europe, the opportunity is more nuanced given the weaker economic environment. GDP is forecast to grow by a tepid 1% this year with interest rates being cut aggressively – three to four is our current expectation.
There are good credits in the market but rigorous analysis and selection is key. In contrast to the US, we are sticking to an ‘up in quality’ approach for Europe given the weaker economic environment. We continue to prefer European banks and, in particular, national leaders.
While the rate-cutting cycle has begun across developed markets, the speed and trajectory of recovery across key economies remains uncertain, creating a cloudy outlook and fuelling ongoing volatility.
The US is on course for a ‘no landing’ scenario, which creates potential opportunities for weaker credits to outperform. As such, we view US high yield as our preferred ‘yield generator’ for fixed income investors.
Increasing divergence between the US and Europe means a disciplined, high conviction and highly active investment approach remains essential.
Andrew Lake is head of fixed income at Mirabaud Asset Management. The views expressed above should not be taken as investment advice.