US High Yield Bonds Face Headwinds as Inflation Stalls: Nomura Reports
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US high yield bonds edged lower in April, with the ICE BofA US High Yield Constrained Index (HUC0) declining 1.0% and reducing the year-to-date total return to 0.5%, according to a report published by Nomura. This decline is attributed to stalled progress on inflation and the subsequent rise in Treasury yields.
Nomura's report highlights that while the US saw disinflation in the latter half of 2023, the Core PCE index has returned to a 4% annualized rate in Q1 2024, indicating that inflation remains persistent. This has led to a "higher for longer" expectation for interest rates, as the Federal Reserve is unlikely to cut rates until inflation subsides.
The rise in Treasury yields, with the 10-year Treasury yield increasing by 48 basis points in April, has weighed on returns for high yield bonds. CCC-rated bonds underperformed during the month, with the Cable TV sector experiencing the most significant decline due to issuer-specific activity.
Despite these challenges, the US economy continues to exhibit steady growth, with real final sales to domestic purchasers increasing at a 2.8% annualized rate in Q1 2024. This positive economic outlook has helped keep high yield spreads in check.
"Looking forward, NCRAM feels the yield and carry will drive an attractive total return for high yield this year, while progress on inflation will be a key driver of Fed policy and Treasury yields," Nomura points out.
European High Yield Shows Resilience
In contrast to the US market, European high yield bonds demonstrated resilience in April, with the ICE BofA European Currency High Yield Constrained Index (HPC0) returning -0.02% and 1.89% year-to-date. Spreads tightened during the month, driven by BB-rated bonds, as Bund yields increased while cash high yield bonds remained relatively stable.
The European economy is showing signs of recovery from a period of negative growth, and while inflation remains persistent, the trend suggests potential for an ECB rate cut in June. Technical factors also remain supportive of European high yield, with modest new issue activity and ample cash available to absorb new supply.
"New issues picked up at the end of April as issuers pushed forward their plans to refinance their 2025 and 2026 maturities given the healthy capital markets," notes Nomura.