Junk Bonds Ride Mixed Market Messages

The credit-sensitive high-yield debt sector is floating through a macroeconomic paradox.

What should investors and financial advisors do about junk bonds in this market? 

In an environment where even FDIC-insured savings accounts are yielding north of 4%, it might feel a little greedy and unnecessary to lean into below-investment-grade debt for yields hovering in the 8% range. 

But that’s what financial advisors and market watchers get paid to stress over, and stress over they are. “High yield has been an interesting, if not head scratching, story all year,” said Fran Rodilosso, head of fixed-income ETF portfolio management at VanEck. 

The bond market rebound this year, coming off a negative 2022, is well documented. But the high-yield sector is interesting because of the way it often acts more like a stock than a bond. 

The SPDR Bloomberg High Yield Bond ETF (JNK) is up 8.77% this year following a 12% decline last year. The iShares iBoxx USD High Yield Corporate Bond ETF (HYG) is up 8.09% following an 11% drop last year. 

Market watchers remain flummoxed about how to navigate this credit-dependent slice of the fixed-income market because of so many conflicting macroeconomic realities surrounding its run this year. 

“What you’re getting is a more dovish Fed, softening jobs data and an outlook for companies that would be in the junk space that looks better,” said Chris Shuba, founder and chief executive of Helios. 

While categorizing the above as a “pretty cool combo,” Shuba said investors can’t ignore the reality of a stubbornly inverted yield curve. 

“The big bugaboo is the inverted yield curve,” he added. “We’re just living in bizarro world.” 

Junk Bonds Roll On 

By some measures, junk bonds will need the Federal Reserve to start cutting rates for the run to continue. But that’s not any kind of lock at this point. 

“A soft landing is the new base case, and that’s good for credit,” said Eric Hess, senior managing director and high-yield sector head at Newfleet Asset Management. 

“If inflation goes down the Fed can start cutting rates and that benefits every investable asset,” he added. “Some people are looking at those [junk bond] yields and think you can have some credit losses and still do pretty good.” 

Rodilosso of VanEck also sees the mixed messages facing the high-yield market. 

“Credit spreads are pricing in a very soft landing going into 2024, whereas an inverted yield curve is an indicator that rates will have to come down, which is often because of an economic downturn,” he said. “I don’t think it’s a time to sell your high yield, I just don’t think it’s a time to add risk, but we do like the idea of moving up in quality even in high yield.” 

Contact Jeff Benjamin at [email protected] and find him on X: @BenjiWriter