Since the high yield bond market lows in mid-November, prices recovered and have now moved somewhat above the late-October highs. This process has been slow—and we remained suspect that an intermediate-term trend had not been established. Now, however, we believe probabilities have increased that prices will continue to move higher, reflecting a systemically strong trend.

Intermediate-term price strength often continues while credit spreads tighten. From the current level, a 100-basis-point tightening of spreads would move the risk premium to historical lows and reflect expectation for a yet stronger economy and yet lower defaults.

Treasury Yield Considerations

But of course risks remain. The 10-year Treasury yield broke the resistance area of 2.63% that we have been monitoring, reaching 2.66%. A further increase in yield would suggest that fixed income in general will struggle.

A breakout of yields to new highs could spur additional bond selling—but such a breakout does not appear imminent. Despite indications that central banks may be slowing their purchases of U.S. Treasuries bonds- a high bid to cover ratio after at a recent auction of the 10-year note- suggests that a strong ‘bid’ remains and current yields are attractive.

The recent move up in Treasury yields may be a reason that high yields have not shown their typical correlation with stocks in recent months. At this point in the business and credit cycle, credit spreads are relatively tight, potentially limiting upside in high yields in the short run. That said, it is possible that high yields may “catch up” with the stock market, especially if Treasury yields fall back.

Additionally, there is the potential for spreads to tighten to all-time lows, which could lead to price appreciation in addition to income from the approximately 5.25% interest yield.