US high-yield bonds have shown remarkable resilience in 2023. Lord Abbett explores the factors contributing to this resilience, pointing to the inflation environment, high nominal growth rates, and financial policies as key drivers.

“In our view, these factors could also provide for enduring strength in public credit markets for many years to come,” writes Riz Hussain, Investment Strategist, Leveraged Credit at Lord Abbett. Hussain informs that periods of high inflation have not resulted in higher default rates. The ability of corporations to translate high inflation and nominal growth into cash flows has helped service debt, reducing the real burden of past liabilities, adds the asset manager.

Hussain attributes recent corporate resilience to built-up liquidity during the pandemic, combined with strong nominal growth. Looking ahead, Lord Abbett points out that the distressed ratio for US high-yield bonds is at 7.4%, implying a manageable 3% default rate for the upcoming year. Separately, it examines the relationship between inflation and profit margins. The asset manager asserts that despite recent inflation easing, profit margins remain elevated, providing a solid base.

“While the distress ratio implies a non-recessionary level of defaults in the year ahead, we believe the historical relationship between inflation and profit margins can provide another argument against expecting a severe default cycle near-term,” says Lord Abbett.

Following this, Hussain highlights recent findings from JPMorgan, revealing that when it comes to U.S. high-yield bonds, there has been a higher incidence of upgrades for BB and single-B issuer ratings compared to downgrades. Conversely, the CCC-ratings cohort has experienced the opposite trend.

“While the higher rate environment is impacting the more levered entities with less financial and operating flexibility (perhaps somewhat by monetary policy design), those issuers higher in ratings quality may actually be engineering themselves to obtain higher ratings to reduce the bite of a higher / normalised financing rate regime,” opines Lord Abbett.

In conclusion, the asset manager suggests that the resilience in the high-yield credit market can be attributed, in part, to supportive fundamental factors in a higher inflation and nominal growth environment.

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