“Spreads can go tighter, though not meaningfully tighter,” Ken Monaghan, co-head of high yield at Amundi U.S. told the Reuters Global Markets Forum on Tuesday.
The additional yield, or the yield spread, that investors demand for holding riskier corporate bonds over U.S. Treasuries fell to near its tightest level since the Great Recession due to investors buying higher yielding assets.
Amundi’s Monaghan pointed to BB-rated bonds comprising a greater share of the high yield market as a primary reason why spreads are unlikely to tighten significantly.
He said the bonds are now nearly 55% of the market compared to about 45% a decade ago and pointed to demand by “crossover investors” seeking returns higher than those available in investment grade corporate credit and U.S. government debt markets.
“If nominal rates were to move meaningfully higher on an eventual Federal Reserve move, would those … who have ‘vacationed’ in high yield return to their home markets? Probably some would,” Monaghan said.
The Fed began unwinding its corporate bond portfolio last week, with markets focused on when it will taper its hefty asset buying program.
Monaghan said the Fed’s moves have had a less dramatic impact on high yield debt, with even a hawkish tone from the central bank not pushing up spreads significantly.
While many corporate defaults were expected due to the COVID-19 pandemic, Monaghan said default levels remained below expectations, thanks mainly to the Fed’s backstop and numerous “rescue” programs.
Despite current “risk-on” sentiment, Amundi’s Monaghan said aggressive borrowing seen in previous cycles has not materialized, with most companies focused on refinancing existing debt.
(Reporting by Lisa Pauline Mattackal and Aaron Saldanha in Bengaluru; Editing by Arun Koyyur)