United StatesHigh yield credit spreads over US Treasuries are currently near record lows of around 300 basis points.1 This is despite yields that remain close to decade highs.2
Does logic dictate that high yield spreads should widen and revert to more ‘normal’ levels? We argue not.
We see four compelling reasons why the tight spread environment can persist given robust economic and company fundamentals, supportive technical factors, and strong underlying demand.
1. The economic backdrop is constructive
Strong economic and stockmarket performance are generally very positive for high yield assets.
While the European economy remains stable, with lethargic growth rates, the US economy is in robust shape, recording growth of almost 3% in 2024.3 Proposed extensions to corporate and individual tax rates and a drive towards deregulation are expected to further support near-term US growth.
Coupled with recent interest rate cuts in the US and Europe, this is a constructive environment for high yield issuers, who tend to be smaller and more heavily indebted companies. Supported by lower borrowing costs, credit metrics should improve and allow these companies to deleverage or re-finance more easily.
Meanwhile, listed equities – in the US, at least – trade at historically elevated levels, in effect underpinning valuations of riskier corporate bonds. Many high yield investors look to equities for valuation comparison and enterprise value justification, taking comfort when there is an equity ‘cushion’ beyond bonds in companies’ capital structures. This can result in greater risk tolerance for issuers with heavy debt loads and this dynamic can remain until there is a material sell off in equity markets.
2. High yields and low default rates support prospective returns
Relatively high yields combine with low expected default rates to paint an encouraging medium-term picture for high yield investors.
It may seem obvious, but starting yields matter considerably for high yield investors. Historically, the vast majority of long-term returns in this asset class are driven by coupon income.4 As of 9 January 2025, yields across the overall US and global high yield bond markets were 7.4% and 7.2%, respectively. Although yields fell in 2024, they remain higher than at most times during the past 15 years, as illustrated below.5
Subhead: Yield to worst (%)
Overview: This line chart illustrates the yields of both US and global high yield bond markets, overall, from the start of 2010 to the end of 2024.
Category one: ICE BofA US Cash Pay High Yield Constrained Index
Category two: ICE BofA Global High Yield Index
Overall, this chart shows how both US and global high yield bond yields have risen in lockstep from pandemic-era lows of around 4% to just over 7%, which is above the average for the past 15 year period. Yields peaked at close to 10% in late 2022.
Source: ICE, 31 December 2024
Meanwhile recent default activity among high yield issuers has generally been limited to liability management exercises (LMEs) and forecasts for defaults remain low, in a historical context.6 Par-weighted default rates within US high yield stood at 1.5% at the end of 2024 – and only 0.3% once LMEs are excluded. During the global financial crisis they spiked above 20% (see chart below).7
A significant number of the largest heavily indebted companies in the benchmark have already undertaken LMEs which has given them longer maturity runways and enhanced their near-term liquidity.8 A number of other stressed companies have had ‘creditor co-ops’ form pro-actively which should protect bondholders if future LMEs are required. This should reduce the magnitude of defaults and realised default losses in the near-medium term, which should provide support for overall spreads.
Subhead: Par-weighted US and global high yield default rates (%)
Overview: This line chart illustrates the default rates of both US and global high yield bond markets, overall, from the end of 2005 to the end of 2024. It also includes default rates for US high yield bonds excluding liability management exercises, or LMEs, since January 2020.
Category one: US high yield
Category two: US high yield excluding LMEs
Category three: Global high yield
Overall, this chart shows how both US and global high yield bond market default rates are close to two-decade lows at the end of 2024, at 1.5% and 1.8% respectively. When LMEs are excluded, US high yield default rates are only 0.3%. US and global high yield default rates spiked at 21.3% and 19.4% respectively in late 2009, during the global financial crisis, and only briefly rose as high as 7.3% and 6.0% respectively during the pandemic.
Source: BofA Global Research, 31 December 2024. Data for US High Yield ex-LMEs available from January 2020.
3. Maturity, credit quality, duration and diversification concerns have abated
Four issues weigh less heavily on the high yield market today than in recent years and have changed its character, complicating historic comparisons.
First, ‘maturity walls’, being high volumes of debt approaching maturity, are no longer as concerning as they were only a year ago. At the end of 2023, almost US$500bn in bonds were due to mature in 2025 and 2026 across US dollar, Euro and Emerging Market high yield debt. By the end of 2024, this had fallen to roughly US$300bn as strong primary markets have allowed many high yield issuers to recast their near-term maturities (see below).9 In the event that the market outlook darkens, this should provide support for lower spreads as indebted companies will not be as reliant on a receptive primary market for refinancing as they were.
Subhead: Maturity profile of high yield bonds at the end of 2024 ($bn)
Overview: This bar chart illustrates the maturity profile of the high yield bond market at the end of 2024, showing the total value of maturities each year from 2025. Data is broken down by USD, Euro and emerging markets issuances. Dotted lines illustrate the value of bonds that were due to mature in 2025 and 2026 as at the end of 2023.
Category one: USD high yield
Category two: Euro high yield
Category three: Emerging markets high yield
Overall, this chart shows three things. First, the value of high yield maturities falling due in 2025 is significantly lower than in upcoming years. Second, the value of maturities rises each year from 2025 to 2030, especially for US dollar bonds. Third, the value of maturities falling due in 2025 and 2026 is significantly lower than a year earlier, because many issuers have refinanced debt.
Source: BofA Global Research, 31 December 2024
Second, the composition of the high yield market has shifted towards larger, higher quality issuers with lower leverage over the past decade. The share of the US and global high yield markets that is rated ‘BB’ has risen by six and seven percentage points, respectively, to 53% and 59% at the end of 2024. Meanwhile the percentage of each index rated ‘CCC’ (the lowest rating) has declined slightly, as shown below.10
Subhead: Credit rating breakdown by index (%)
Overview: This bar chart compares the breakdown of US and global high yield bond markets by credit rating in December 2014 vs December 2024. It shows the percentage of each market assigned ‘BB’, ‘B’ and ‘CCC’ ratings, respectively.
Category one: US high yield ‘BB’
Category two: Global high yield ‘BB’
Category three: US high yield ‘B’
Category four: Global high yield ‘B’
Category five: US high yield ‘CCC’
Category six: Global high yield ‘CCC’
Overall, this chart shows that the credit quality of both the US and global high yield markets, as measured by credit rating weightings, has improved between 2014 and 2024.
Source: ICE, 31 December 2024
Third, the high yield market’s duration – a measure of interest rate risk – has shortened from around four years to closer to three years.11
Fourth, the high yield market has become more diversified by sector. A decade ago, over 26% of the US high yield market was dominated by the top two sectors. Today, that share is just over 20% and no single sector accounts for more than 12% of the US benchmark, reducing the risk of sector-specific shocks and helping to limit default rate expectations.12 The global high yield market has similarly become more diversified.
4. Technical factors look supportive
Two other factors supportive of low spreads are expectations of only modest net issuance and increased mergers and acquisitions (M&A) activity in 2025.
First, supply is an important determinant of bond pricing. There is expected to be minimal growth in the net new supply of high yield bonds in 2025, continuing a recent trend driven by both substantial growth in the leveraged loan and private credit markets and the ‘promotion’ of several large issuers to investment grade status. We do not expect any surge in ‘fallen angels’ to expand the size of the high yield market in the near term, so this supply-demand dynamic is set to continue exerting downward pressure on spreads.
Second, it looks highly probable that M&A activity in the US will increase under a Trump administration that favours deregulation and sets a higher bar for intervening on anti-trust grounds. Any wave of consolidation within industries would likely support the prospects of smaller high yield issuers, many of which can be attractive acquisition targets.
Potential risks can be mitigated
These positive factors notwithstanding, we acknowledge and monitor two primary risks facing the high yield market: slower economic growth and higher inflation.
A material slowdown in economic activity is the most significant risk given its likely negative impact on equities, whose valuations have had very high historic correlations with those high yield bonds. In this scenario, wider credit spreads would drive bond prices lower but, so long as inflation remains moderate, this would be offset somewhat by the expectation of lower interest rates in a weaker economic environment.
A more adverse scenario would contemplate inflation remaining sticky or higher, possibly due to trade tariffs coupled with an economic slowdown. In this scenario, we believe that individual credit selection would be as important as ever in generating excess relative returns.
1 Spread-to-worst, as at 9 January 2025. Spread-to-worst is the difference between the yield-to-worst of these bond indices and yield-to-worst of US Treasuries of comparable duration. US High Yield (ICE BofA US Cash Pay High Yield Constrained Index) spread-to-worst – 298; Global High Yield (ICE BofA Global High Yield Index) spread-to-worst – 315.
2 ICE, January 2025
3 Bloomberg, January 2025
4 ICE BofA US Cash Pay High Yield Constrained Index, ICE BofA Global High Yield Index
5 As at 9 January 2025, the respective yields to worst for the ICE BofA US Cash Pay High Yield Constrained Index and the ICE BofA Global High Yield Index were in the 71st and 66th percentiles in the period starting 1 January 2010. Source: ICE, 9 January 2025
6 JPMorgan, December 2024
7 BofA Global Research, 31 December 2024
8 JPMorgan, January 2025
9 BofA Global Research, 31 December 2024
10 ICE, Impax Asset Management, December 2024
11 ICE, December 2024
12 ICE, December 2024
Nothing presented herein is intended to constitute investment advice and no investment decision should be made solely based on this information. Nothing presented should be construed as a recommendation to purchase or sell a particular type of security or follow any investment technique or strategy. Information presented herein reflects Impax Asset Management’s views at a particular time. Such views are subject to change at any point and Impax Asset Management shall not be obligated to provide any notice. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary. While Impax Asset Management has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third-party information presented herein. No guarantee of investment performance is being provided and no inference to the contrary should be made.