high yield bonds

Central banks have taken on a renewed focus for corporate bond investors given China’s recent moves to tighten monetary policy. Over the past two weeks, concerns over policy tightening in China have led to US Treasuries outperforming more credit sensitive corporate bonds. This week, all eyes shift towards the Federal Reserve’s Federal Open Markets Committee (FOMC) meeting. While an interest rate change is not expected, investors will closely scrutinize the FOMC’s statement for any movement towards an exit strategy and removal of monetary stimulus. If the Fed takes a step towards removing stimulus, investors may view the economy as being at risk for a possible “double dip” recession and thus question the future creditworthiness of corporate bonds.

photo credit: George E.Martin

A look back at prior episodes of Fed monetary-policy tightening reveals that corporate bonds, both investment-grade and high-yield, continued to outperform Treasuries following the start of interest rate hikes in 1994 and 2004. Visually, the easiest way to see the out-performance of corporate bonds is to view the change in yield differentials, or spreads, to Treasuries. A narrower yield spread reflects stronger investor preference for corporate bonds, while a wider yield spread reflects weaker demand for corporate bonds and stronger demand for Treasuries.
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