High yield credit: update

US and euro corporate bonds have been performing well year-to-date, helped by tightening credit spreads and a comfortable carry. US HY bond yields remain above 7% on average (according to the ICE Bank of America index on 12 September). While profit margins showed signs of coming under pressure, Q2 earnings reports painted an overall picture of stable leverage ratios. In addition, the US HY bond default rate fell to a relatively low 2.8% in July. We would expect the upcoming Fed rate cuts to provide some breathing room to indebted companies with noninvestment-grade ratings.

The highest-quality segment (BB-rated names) has increased its share of the US HY bond universe, while the share of the riskiest segment (CCC-rated) remains relatively low and stable. Our improved stance on US HY (we have moved from underweight to neutral) also stems from the divergence we see between spreads on the riskiest segment—which are close to distressed levels (above 1000 bps) and which we avoid—and the tighter spreads on bonds with a much lower probability of default. We further believe that upcoming Fed rate cuts and the resilience of the US economy will help US HY’s prospects.