CIO’s Perspective: 2021 High Yield Market Review and 2022 Outlook
- After a turbulent 2020, leveraged credit markets enjoyed comparatively smoother skies in 2021. That said, positive news to start the year gave way to the apprehension and uncertainty associated with new COVID-19 variants and rising inflation.
- In 2022, while the environment seems conducive for another year of modest gains in the leveraged credit markets, it will likely be accompanied by heightened volatility.
After a turbulent 2020, leveraged credit markets enjoyed comparatively smoother skies in 2021. Additional fiscal stimulus to start the year and an accommodative monetary policy, as well as “re-opening” momentum on the back of vaccine availability and distribution, helped fuel strong economic growth during the year. Furthermore, another year of wide open capital markets along with improved issuer fundamentals pushed default rates to near record lows. That said, positive news to start the year gave way to the apprehension and uncertainty associated with new COVID-19 variants and rising inflation.
Will 2022 bring more of the same or something new? The current inflationary environment is leading market participants to forecast several rate hikes by the U.S. Federal Reserve (“the Fed”) during the year to combat any potential overheating in the economy. A rising rate environment could spell trouble for fixed rate high yield bonds. However, on a relative basis, high yield bonds remain attractive to other fixed income alternatives. In addition, the floating rate coupons offered by leveraged loans provide some protection against rising rates, which will potentially lead to another year of net inflows for the asset class. In 2022, while the environment seems conducive for another year of modest gains in the leveraged credit markets, it will likely be accompanied by heightened volatility.
2021 CREDIT MARKET REVIEW
The more things change the more they stay the same.
In 2021, the high yield bond and leveraged loan markets were supported by additional fiscal stimulus, continued economic growth, commodity price rallies, monetary policy support and the successful roll-out of vaccines across the population. Unfortunately, as the year wore on, momentum from the above tailwinds gave way to the volatility-inducing angst created by rising inflation and a pair of COVID variants sweeping the globe. Although the high yield bond and leveraged loan markets produced gains of 5.36% and 5.40%, respectively, 2021 was a tale of two halves (Table 1).
Regardless, for both markets, performance in 2021 proved to be dominated by coupon income or “carry” (Table 2). This outcome is not surprising given the environment described above and the subsequent increase in U.S. Treasury yields during the year. For context, the 2-year, 5-year and 10-year U.S. Treasury yields climbed by 60 basis points (“bps”), 90 bps and 59 bps, respectively. However, while longer-dated yields increased during the first half of the year, spread compression offset the bulk of the move in rates, thereby enabling high yield bonds to make modest price gains during that period.
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