While various risks exist around the world, overall we believe global high yield bonds look attractive with improving global growth and low default rates.
US HIGH YIELD
We think US high yield will be supported by stable real and nominal growth in the US. We expect defaults to remain low in 2017, and our base case calls for a 2%-3% default rate. Also, the price of oil has recently rebounded above $50, and we expect oil to remain in the $50-$60 range for the rest of the year, supporting the important energy sector.
Should the Trump administration succeed in pushing through effective tax reform, deregulation, and infrastructure spending, we
would expect a positive impact on the US economy.
GLOBAL HIGH YIELD
With regard to European high yield, the European and global economies seem to be improving, and the credit quality of the European high yield market has steadily improved in most sectors. We expect default rates in Europe to remain quite low.
From a supply/demand standpoint, we have been a bit surprised by the volume of net new issuance, including from new issuers to the market. In the short term, this has caused some indigestion; however, we believe the new supply will ultimately be well absorbed in the market.
We continue to expect strong demand for yield products globally and note that, on a spread basis, European high yield appears to have gotten relatively more attractive versus US and emerging markets (EM) over the last few months.
A major risk factor in the year ahead is the numerous elections throughout the European continent which may have implications for the form and future of the European Union. Emerging markets high yield has led US and European high yield (in local currency terms) early in 2017. The market appears to have confidence that global economic growth is accelerating.
Evidence of this has emerged in various forms, from strong jobs data in the US, to better industrial production in Europe, and a sense that certain large emerging market economies should be returning to growth this year. Quantitative easing (QE) outside of the US may be having a constructive effect, while the potential for fiscal stimulus in the US has added to the positive feelings. Overall, stable global growth supports global high yield.
GLOBAL MONETARY POLICY
In regards to US central bank policy, we expect a slow and gradual pace of tightening. After the Federal Reserve Bank (Fed) raised rates by 25 bps both in December 2016 and March 2017, the Fed may move forward with more rate hikes in 2017, because unemployment has fallen and inflation has risen. The election of Donald Trump and the potential for significant fiscal stimulus increases the possibility of a more active Fed. We expect two additional increases in 2017 and two more in 2018.
Here is the path of the Fed Funds rate as implied by the futures market:
The evolution of the European Central Bank’s (ECB) stimulus program continues to be a major risk factor going forward. The ECB’s decision in early December to extend but shrink its quantitative easing program, coupled with the continuation of the Corporate Sector Purchase Programme, should provide ongoing technical support to European credit markets. However, as growth improves in Europe, we do expect a taper later in 2017.
In summary, we believe stable global growth provides an attractive environment for global high yield investing this year. We believe monetary policy is supportive to high yield markets globally even as we anticipate additional rate hikes by the Fed and a potential taper from the ECB, given the generally improved economies in the US and Europe.
We continue to watch the political environment in Europe and key elections in France and Germany to assess any impact on our portfolios. We expect capital market conditions for high yield issuers to remain robust throughout the year and project
many positive capital market events such as M&A, equity offerings, and asset sales.
David Crall is managing director & CIO of Nomura Corporate Research and Asset Management Inc. (NCRAM)
This document is prepared by Nomura Corporate Research and Asset Management Inc. (NCRAM) and is for informational purposes only. All opinions and estimates included herein constitute NCRAM’s judgment, unless stated otherwise, as of April 11, 2017 and are subject to change without notice. Use of “we” in the document refers to NCRAM. There can be no assurance nor is there any guarantee, implied or otherwise, that opinions related to forecasts will be met. Certain information contained herein is obtained from various secondary sources that are believed to be reliable, however, NCRAM does not guarantee its accuracy and such information may be incomplete or condensed. Historical investment performance is no guarantee of future results. There is a risk of loss.
Certain information discussed in this document may constitute forward-looking statements within the meaning of the U.S. federal securities laws. Although NCRAM believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be achieved. Forward-looking information is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. An investment in high yield instruments involves special considerations and certain risks, including risk of default and price volatility, and such securities are regarded as being predominantly speculative as to the issuer’s ability to make payments of principal and interest.
The views and estimates expressed in this material represent the opinions of NCRAM and are subject to change without notice and are not intended as a forecast or guarantee of future results. Such opinions are statements of financial market trends based on current market conditions. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provided, and should not be relied upon as legal or tax advice.