The economic data and statements from Federal Reserve officials have led to more challenging conditions for fixed income. Essentially, there is much less certainty about the timing and direction of the Fed’s next move as economic data and inflation have proven to be stronger than expected.
Michael Arone, the chief investment strategist at State Street, sees this as an opportunity for high-yield bonds. He believes that the attractive yield levels, combined with a strong economy, suggest that defaults will remain low. So far this year, high-yield bonds have outperformed, showing a slight positive return, while the iShares Core US Aggregate Bond ETF (AGG) and Vanguard Total Bond Market ETF (BND) have reported year-to-date losses.
This is a contrarian trade due to the fact that high-yield bond ETFs have experienced $387 million of outflows year-to-date, while fixed income ETFs have seen net inflows of $2.8 billion in the same period. It’s also a way for fixed income investors to bet that the US economy continues to defy skeptics and avoids a recession despite the Fed’s aggressive rate hikes.
Presently, high-yield bonds have an average spread of 338 basis points versus Treasuries. The majority of the most popular high-yield ETFs have effective durations between 3 and 4 years, which means there is less rate risk. Spreads have remained relatively tight and could widen in the event of the economy slowing down.
Finsum: High-yield ETFs are offering an interesting opportunity with their attractive yields. This segment of the fixed income market is also benefiting from the recently strong economic data, indicating that default rates will remain low.
- bonds
- ETFs
- fixed income
- yields
- inflows
- high yield
- fed
- macro
- inflation
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
