2022 High Yield Credit Outlook: Views on Policy, Ratings and Opportunity
1. Rising rates can be a double-edged sword for high yield credit. On the one hand, the sector’s shorter average duration can draw fixed income investors away from longer-duration assets when rates are rising. On the other hand, rising rates often go hand in hand with tighter financial conditions, making it more expensive for companies to borrow. How do you expect the sector to perform if rates begin to rise?
We believe strong credit fundamentals and strong earnings growth will continue to support high yield credit spreads in a rising rate environment. Credit outlook revisions have been positive among Loomis Sayles’ credit analysts and street analysts, suggesting that more companies are likely to have their credit ratings upgraded rather than downgraded. We believe this trend of positive credit outlook revisions will continue into 2022, helping to provide a potential tailwind for the high yield market.
When it comes to duration, we think high yield credit currently stands out relative to other US credit offerings because of its relatively attractive yield per unit of duration (see chart below).
2. Some market participants are expecting CCC-rated bonds to outperform this year, due to low defaults and attractive carry. Do you agree with that take?
We don’t disagree that CCC-rated corporate bonds have traditionally offered an excess spread that can act as a natural hedge against rising base rates. However, we currently view single-B-rated corporate bonds as a better trade in 2022.
We believe that CCC-rated corporate bonds will struggle as we progress through the expansion phase of the credit cycle, which has historically been a phase when CCCs lag both BB and B-rated bonds. There’s also potential defaults to consider. While we expect the low default environment to continue into 2022, we believe defaults reached a cycle low in 2021. We think investors will likely price an additional risk premium into CCC cohort as default rates gently increase.