We believe income investors should maintain exposure to high yield bonds in this environment. With the Fed on hold, interest rate volatility may remain at low levels. A sharp, unexpected rise in rates is certainly a risk investors must be aware of. Higher yields, however, can provide a cushion against rising rates, and higher growth is positive for spreads. Over the past decade, the correlation of US and emerging markets high yield corporate bonds to inflation, although not strongly positive, is only slightly below that of US equities and higher than investment-grade bonds and US Treasuries (which has a negative correlation). Interestingly, their correlation to inflation is also higher than US REITs and similar to natural resources equities. The asset class yields approximately 5.6%, which is well above the Fed’s stated inflation target of 2%, potentially allowing income investors to out-earn inflation and maintain purchasing power.
Emerging markets high yield corporate bonds denominated in US dollars may be particularly attractive and provide a way for income investors to benefit from higher global growth which is expected to reach 5.5% this year, according to the International Monetary Fund, reflecting an upward revision from their October estimate.
