Barings: High yield outlook

Martin Horne, head of European High Yield and Mike Freno, head of US and Global High Yield Investments give their outlook on High Yield in 2017.

Barings: High yield outlook

US and European central banks are expected to move in different directions, with the US Fed tightening monetary policy last week and the ECB expected to continue easing. This potential divergence will impact the US and European high yield markets differently, and may create relative value opportunities across the two regions.

With interest rates still near historical lows in the US and Europe, the search for yield continues. While the strong performance of high yield bonds in 2016 has pushed credit spreads and yields lower, the yield offered by high yield bonds in the US remains attractive by historical standards and relative to comparable investment options.

Even as some factors point to potentially higher rates in 2017, we do not expect a rapid rate-hiking cycle in the US and certainly not in Europe. It’s also important to remember that high yield bonds are driven more by credit spreads than interest rate changes.

Technicals versus Fundamentals

Credit fundamentals, overall, appear steady. While it’s likely that we are closer to the end of the current credit cycle than the beginning, it is also important to note that since the financial crisis, high yield markets have almost continuously faced risk flare-ups—most recently, these have included US and UK geopolitical shocks.

As these risk events have pushed credit spreads wider, they have also created opportunities for nimble high yield managers. Often, these continued risk flare-ups have also resulted in more conservative balance sheet management by high yield issuers, which has kept leverage and interest coverage measures in reasonable territory, implying that the asset class remains on solid footing.

Technical factors such as fund flows, CLO formation, and new issuance volume can create relative value opportunities across asset classes (loans and bonds) and also across the US and Europe. Often, during times of economic uncertainty or macro volatility, high yield bond prices will become decoupled from the underlying fundamentals. These opportunities can evaporate as quickly as they appear, and as such, it is important to monitor markets closely and to cover a broad universe of high yield credits in order to capitalize on the opportunities as they arise.

Energy & Commodities

We expect the energy and commodity sectors to be less volatile in 2017 compared to 2016. However, some volatility in these sectors will likely persist and may present opportunities both within the commodity sectors and in other sectors where valuations decouple from fundamentals.

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