EC Junk Bonds Continue To Lead US Fixed Income Markets In 2021

Stay short and favor junk bonds. That, at least, is what’s worked rather well so far this year, based on a set of ETFs representing the major slices of US fixed-income markets. But as reflation heats up, is the already stretched high-yield market headed for trouble?

What hasn’t worked is going long Treasuries this year. The deepest loss for the ETF proxies: iShares 20+ Year Treasury Bond (TLT), which is down a hefty 11.8% so far this year.

By contrast, all is well with junk bonds, which have outperformed. The leading year-to-date return for our fund set at the moment: SPDR Bloomberg Barclays Short Term High Yield Bond (SJNK), which is up 2.7% this year (Apr. 27).

Its longer-maturity cousin — SPDR Bloomberg Barclays High Yield Bond (JNK) – is in third place with a 1.1% total return.

The question is how much upside performance is left for junk bonds? The premium in junk yields over Treasuries has fallen to 3.26 percentage points (Apr. 26), based on the ICE BofA US High Yield Index Option-Adjusted Spread. That’s the lowest level in 14 years and a sign that expected return is relatively thin, perhaps even negative.

It’s possible, of course, that junk can continue to rally, especially if interest rates continue to fall. But for the immediate future, rates are trending higher as the Treasury market prices in expectations of firmer inflation. Perhaps that’s a temporary affair, but for now, the headwinds appear to be building for junk in the near term.

In a sign of the times, short-maturity inflation-protected Treasuries are the second-best performer this year. The combination of staying cautious by hugging the shorter end of the yield curve and adding inflation protection appears to be a popular trade these days.

“It’s hard to say if inflation is a primary concern right now, but there’s a strong case to be made that inflation could continue to tick higher over the next several years as the economy heats up,” says Douglas Boneparth, president of Bone Fide Wealth in New York.

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Disclosures: None.

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