Supply and demand dynamics supporting markets
Peter Keenan, Senior Trader on the BlueBay U.S. Fixed Income team, discusses the current state of high yield bonds, highlighting key themes and pressure points driving markets in the US.
Key points:
- US High Yield has been resilient despite recent geopolitical turbulence.
- High yield is a beneficiary of both strong demand and limited supply. Inflows into the asset class have largely been driven by ETFs.
- Demand has been high, and investors are sitting on cash, providing support. The supply side has also been helpful, as new issuance has been low.
- Spreads have also ticked up from earlier in the year, making this an attractive entry point.
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Welcome back to The Weekly Fix. My name is Peter Keenan. I am a senior trader on the RBC’s BlueBay Leveraged Finance team in Stamford, Connecticut.
US High Yield has been remarkably resilient despite recent geopolitical turbulence. On this week’s edition of The Weekly Fix, I will review the underlying technical set up contributing to that strength. In summary, high yield is a beneficiary of both strong demand and limited supply.
As of last week, high yield mutual funds and ETFs had received inflows of five point three billion dollars year to date, with three point five billion of that money coming in over the last four weeks. Those inflows are skewed towards ETFs – in fact, on a year-to-date basis, ETFs have received seven point six billion while mutual funds have had an outflow of two point three billion. Our view is that ETFs flows tend to be from faster moving money and a leading indicator, while mutual funds tend to be stickier long-term money. So perhaps the imbalance between ETFs and mutual fund flows will find some equilibrium in the weeks to come.
Secondly, high yield investors have cash to put to work. Anecdotal polling of our sell side counterparties indicates that mutual fund cash balances are around 3-4%, a relatively high figure illustrating conservative risk posturing as a result of macro events such as Liberation Day and recent fighting in the Middle East. This is further demonstrated by the mutual fund peer group lagging behind index returns in year-to-date performance – generally speaking, high yield investors are underinvested in the market. According to Bloomberg, the HY mutual fund peer group up 2.99% YTD while index total return has been 3.19%. Underperforming managers will need to find ways to catch up. The week of June 16th, high yield issuers returned eighteen point three billion dollars in the form of coupons, calls, tenders, and maturities back to high yield investors – an extraordinarily elevated weekly number and one of the largest of the year. Weeks where a large amount of cash is returned to investors have a direct relationship on spread tightening as that money must be put back to work.
The supply side is also compelling. Estimates for 2025 US High Yield new issuance by large investment banks ranged from 285 to 340 billion, with one outlier as high as 400 billion. Through the end of last week, there had only been 131 billion issued, which is down 18% from the comparable period last year. With about the half the year remaining, high yield new issuance is underpacing even the most conservative estimates for what the calendar would bring. The market would need a spike in second half issuance to catch up to the run rate required to satisfy full year estimates. For example, we could see more opportunistic issuance as a result of a much lower rate environment or perhaps a spark of M&A and LBO financing if there was increased deregulation led to more activity. But there is a lot of ground to make up.
Lastly, dealer inventories are unlikely to be a source of supply for high yield investors. Dealer balance sheet holdings in high yield bonds are reported on a two-week lagging basis by the New York Fed, and the data suggests that large investment banks generally were derisking headed into Liberation day, aggressively cut risk in April, and have been generally buying back risk through May and into June. While these inventories are off their year-to-date lows, it feels to me that dealers will be a better buyers themselves in the near term rather than a source of bonds for investors to purchase with their cash.
So, with the supply and demand technicals creating a supportive environment for high yield, the question remains – is this a good time to enter the product? The option adjusted spread for the high yield index closed last night at 302 bps. Investors who bought the market in the wake of Liberation Day had a much better entry point, as wide as 450 bps. However, 300 looks attractive when you consider that the index oscillated between 255 and 285 bps between election day and the end of February. If we see a quieting down of middle east tension and some positive resolution of outstanding tariff issues, the high yield market could be setting up for a grind tighter this summer.
Thank you for tuning in to the Weekly Fix and see you next week.