US high yield bonds look poised to prosper

US high yield corporate bonds should offer an attractive investment opportunity in 2025, outperforming other fixed income strategies. The segment is supported by America’s resilient economic growth, and favourable market conditions.

Strong corporate fundamentals in the US have created a favourable environment for high yield credit despite tight spreads over US Treasury bonds. In a context of rising yields, the segment has proven more resilient than investment grade bonds.

Fundamentally, US high yield corporate bonds issuance tends to be higher than equivalent European assets. The segment is also dominated by domestically-focused companies, and can therefore benefit from a growing US economy, which we expect to be further supported by the new US administration’s policies in 2025.

A lack of any sharp growth downturn, plus stronger credit market performance, suggests that US high yield can outperform

Yield levels for high yield corporate bonds also argue in favour of the US market, where they hover around 7.5%, compared with 6% in Europe. Historically, the absence of any sharp downturn in growth, coupled with stronger credit market performance, suggests that US high yield can outperform other fixed income strategies in 2025, including US investment grade.

A supportive new US administration

In the high yield segment, energy, telecommunications and the automotive sectors together account for more than one quarter of the value of outstanding bonds, according to Bloomberg data. The energy sector, which depends on bonds to finance its capital-intensive operations, should benefit from Trump administration policies designed to support the domestic oil and gas industry. Telecoms are also potential beneficiaries if the Trump administration delivers on its planned internet connectivity subsidies, as well as dialing-down regulations.

More broadly, measured by a composite of representative indices - more than 90% of the US high yield market consists of purely domestic issuers, with less than 15% of their sales generated abroad. This suggests that the impact of any global trade tensions triggered by additional tariffs under President Trump should be marginal for high yield issuers. A more business-friendly environment should also benefit corporate bonds in general, while offering some relative high-yield outperformance compared with higher-graded bond issues. On the fiscal side, US tax cuts are likely to be extended under President Trump beyond 2025, or even increased. A reduction in corporate income taxes could also provide a cash-flow tailwind for US high yield corporates, even if total tax cuts may be limited by the US’s fiscal deficits and debt.

We expect default rates to continue their downward trend

Credit spreads little changed

Over the course of 2024, credit spreads remained resilient, tightening by 45 basis points (bps) on both cash instruments and derivatives. Additionally, in the months either side of the US election, credit spreads again contributed positively to strong high yield return. Markets have therefore been consistent in pricing low implied default rates. Simultaneously, realised default rates remained contained, at around 5% in 2024. We expect default rates to continue their downward trend, based on solid balance sheets and issuers’ access to financing. In addition, some leading indicators, such as lending standards, signal a further fall in defaults. This should all bolster the valuation of the asset class.

Finding sweet spots

From an industry perspective, we favour issuers in high-yielding US telecoms. The sector performed well in 2024, thanks to a combination of improving retail price growth that should underpin revenue growth in 2025. In addition, after decades of intense investment into network infrastructure, cash flows should start to improve, and may be further supported by lighter broadband regulation, and lower corporate taxes.

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In the US hospitality sector, luxury hotels are benefiting from increased business travel and may see a further boost if income and payroll taxes on social security benefits decline, benefiting high-income retirees - an important clientele for such hotels. In contrast, the performance of US utilities may be weak in 2025, and we continue to favour hybrid instruments. Given the broadly strong credit quality of the sector, these deeply subordinated instruments still offer attractive yields.

Selectively picking the right issuers is key

Within our coverage, we prefer issuers in the US automotive and auto parts sector over European rivals. We believe that current bond valuations in Europe do not adequately price in headwinds through 2025. Still, issuers in the US automotive sector are vulnerable to a potential slowdown in economic growth and/or rising yields (if Trump administration policies prove inflationary). Selectively picking the right issuers is therefore key.

Finally, we are more cautious on issuers in high yield US healthcare. Under the Trump administration we expect the sector to experience some volatility. Lowering drug prices has always been high on the agenda of both Democrats and Republicans, and given the geopolitical context, US pharmaceutical makers may lose share in the Chinese market. Within the US, pandemic-era subsidies to expand health insurance enrolment are set to expire at the end of 2025. As a result, insurance premium payments may rise, cutting demand.

Overall, the high-yield segment’s resilience, and its higher yields than European and US investment grade bonds’, position it favourably for fixed income investors. Changing US policies, including tax cuts and a business-friendly environment, should also contribute to boosting the relative outperformance of these bonds, offering potentially attractive returns.