European high yield has had a strong run with the risk-on summer months allowing further gains. There are now some darker clouds on the horizon as a COVID-19 resurgence again threatens the economy.
Year-to-date returns for high yield remain negative but the initial bounce-back from the March sell-off was sharp and was followed by a second wave higher into June. The summer months were a little bit slower but returns over the past three months for the Bloomberg Barclays Liquidity Screened Euro High Yield Bond Index are still around 3%. The three key drivers have been:
The economic rebound, with indicators suggesting a rapid recovery in most parts of the economy. For example, much of the survey data is largely back to levels that signal a more stable economy.
A risk-on summer, as equity markets pushed higher. This fed through into optimism that downgrade and delinquency risk for high yield bonds had diminished.
The hunt for yield. With European government bond yields largely in negative territory and investment grade (IG) spreads having compressed to their tightest levels since February, fixed income investors needed to look for alternative sources of return. High yield offers both yield and the opportunity for gains as spreads to IG compress.
The resurgence of COVID-19 and talks of new regional lockdowns raise questions over the degree to which the economic numbers can continue to improve. These hurdles are likely to act as a headwind to further high yield performance. However, with yields at over 3.5%1 , capital appreciation is less of a concern for holders of high yield funds.
That said, as long as the appetite for risk stabilises, high yield bonds should be able to continue to perform. As Figure 1 shows, the Bloomberg Barclays Euro High Yield Index has a high correlation to the S&P 500, which places it firmly in the risk asset category. Since March, the index’s reaction to some of the bigger swings in equities has been limited. In this respect, there may be some interest from market participants nervous about the recent instability in stocks to trim equity exposure and favour high yield.
Figure 1: High Yield is a Risk Asset but Has Been More Stable than Equities