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February 2023

Benefits of Owning High Yield Bonds Are Compelling

Key Points

  • Federal reserve policy is key for the bond market
  • Yield curve inversion indicates positive long-term bond returns
  • High yield bonds provide adequate compensation for risk

The end of 2022 marked a handoff from inflationary to growth concerns, creating volatility in fixed income markets. US Treasuries continued their historic upward pace, peaking for the year in October at an intraday high of 4.33%.1

Federal Reserve policy remains key, and higher rates are likely to create problems for the economy. The market for global high yield bonds staged a rally as clarity around a potential stopping point for the Federal Funds target rate firmed, although the rate will continue to climb. Investment Grade bonds showed signs of life toward the end of the year, orchestrating a turnaround fueled by a short-lived peak and subsequent decline in yields, which fell 0.42%1 and ended the year at 3.90%.1 Fixed income markets generally rose in Q4, with the broad aggregate investment grade index finishing up 1.87%2 and US High Yield bonds surging 4.17%.3

The Higher-for-Longer environment is still here, which benefits cash investments. As a proxy for liquidity management, 6-month US Treasury Bills yield 4.81%.4 Bonds with longer maturities also have higher yields, and the potential for a mild recession will make interest rate exposure increasingly attractive during 2023. The historic yield curve inversion, a phenomenon characterized by lower long-term rates relative to short-term rates, is a forward signal that long-term bonds will rise. The difference between 2-year and 10-year US Treasury notes was as low as -0.84% in December, a level last reached in October 1981.

While the risk of a recession has increased, the benefits of owning high yield bonds are compelling. We expect high yield to face pressure during 2023, but with income levels above 8%,3the market is providing adequate compensation for the potential risks. The historically low level of defaults is unsustainable, and it is likely to rise to long-term averages of 4%–5%,5 but this is unlikely to result in persistent negative returns.

Projections for a mild recession indicate that returns across taxable fixed income markets are likely to rebound from a challenging 2022. Current yield levels will help alleviate the strain on fixed income even if rates continue to rise, and further clarity on inflation and growth is likely to relieve pressure on the market.


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