Why the outlook for below–investment-grade bonds is positive

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Last week’s issuance

The yield on the U.S. ten-year Treasury increased to 2.7% from 2.6% the previous week after Janet Yellen reiterated her plans to continue with tapering.

The BAML Index, which tracks the high yield bond market, remained low, leading the credit spread between the two bonds to fall 13 basis points last week. Bond yields move inversely to their prices. Overall, the high yield bond market remained stable, and prices for both HYG and JNK were up 1%.

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The long-term outlook on the U.S. economy remained positive. However, the data released last week wasn’t very impressive. A lower-than-expected labor market and disappointing retail sales contributed to a bearish economic outlook, which is bullish for bonds. Investors blame the fall in economic indicators to extreme weather conditions and hope the figures will rebound as the summer approaches.

U.S. leveraged loan market outlook

Activities in the leveraged loan space are taking advantage of the continued compression in credit spreads. Issuers remained quite active, with a large number of deals hitting the market. However, while the SPY ETF was up 2%, both the S&P/LSTA Leveraged Loan Index and BKLN prices were down last week.

Leverage loan Index vs. S&P 500 ETF

In the short run, demand on the leveraged financial market remains positive—particularly for leveraged loans. However, demand has been flip-flopping for high yield bonds as investors anticipate a rise in interest rates with continued Fed tapering. In fact. last week, we saw an upside on the Treasury rates. This actually benefited leveraged loans, which essentially pay a floating interest rate and tend to adjust to changes in the benchmark rate.

However, high yield bonds rallied as fund flows broke off two consecutive weeks of outflows that compressed spreads and were able to offset the increase in Treasures. Corporate bonds (BND) offer less risk but a lower yield, and high yield bonds offer a higher yield but higher risk both in terms of rating and interest rate sensitivity. Leveraged loans (BKLN) present a very attractive proposition for investors wanting to reduce interest rate sensitivity but maintain a decent yield.

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