By Timothy C. Murray

Download the PDF

The Fed’s big cut may favor high yield bonds

The Fed’s September rate cut reduced the risk of a recession. High yield bonds may benefit.

October 2024, From the Field -

Key Insights

Historically, high yield bonds performed well after the first rate cut in a Federal Reserve easing cycle if that move was not followed by a recession.
The Fed’s large September cut improved the odds of avoiding a U.S. recession. Strong credit fundamentals and attractive yields are also supportive.

After a lengthy wait, the U.S. Federal Reserve began cutting interest rates in September. Many investors may be wondering how this could affect their fixed income allocations.

Initially, at least, markets viewed the Fed’s first cut of 50 basis points (0.5 percentage point) as positive for the U.S. economic outlook. Longer-term yields, which are sensitive to changes in economic expectations, rose over the week following the Fed’s move.

Historically, long-term investment-grade (IG) bonds have tended to be an excellent hedge against economic weakness but less attractive when the economy strengthens. High yield bonds, on the other hand, have tended to benefit from economic strength. This being the case, bond investors may want to consider the mix between IG and high yield bonds in their portfolios.

High yield performance after Fed cuts

On average, the Bloomberg U.S. High Yield Index has returned 4.44% in the 18 months after the Fed has embarked on a rate-cutting cycle. But the range of outcomes has been very wide (Figure 1).

High yield performance after the Fed’s first cut

(Fig. 1) Performance of Bloomberg U.S. High Yield Index over following 18 months

Past performance is not a reliable indicator of future performance.
*First Fed cut is defined as the first month in which the federal funds effective rate fell 0.25% below
the trailing 12-month peak.
Sources: Bloomberg Finance L.P. T. Rowe Price analysis using data from FactSet Research Systems
Inc. All rights reserved.

These results depended heavily on whether a recession occurred after the Fed’s initial cut. In three out of the four cases where a recession did occur in the next 18 months, high yield bonds produced negative double-digit returns. In the fourth case, after the Fed cut rates in August 2019, high yield bonds fell sharply once the COVID pandemic hit the U.S. economy six months later, but bounced back when that recession proved to be deep but very short.

Results were much more encouraging when an initial Fed cut was not followed by a recession. In all three cases, high yield bonds provided positive returns. But those gains were relatively modest after the Fed starting cutting rates in 1998, and a U.S. recession eventually hit in 2001.

High yield fundamentals appear quite strong

On the bright side, several key metrics used to gauge the health of the high yield market remain high by historical standards. This is typically not the case before the onset of a recession.

As of June, earnings before interest, taxes, depreciation, and amortization (EBITDA) were almost five times interest expense in the high yield universe—below the recent peak of 5.77 but above the highest level reached from 2008 through 2020.¹

This was true even after we adjusted EBITDA for capital expenditures.

Attractive yields versus equities

Lastly, high yield bonds now offer attractive yields—not only relative to other fixed income assets but to equities as well (Figure 2). At the end of August, the Bloomberg U.S. High Yield Bond Index had a yield to worst² of 7.3%, while the earnings yield for the S&P 500 Index was only 4.7%.

Yields are attractive on a relative basis

(Fig. 2) Equity, fixed income, and cash yields*

January 2010 to August 2024.
Past performance is not a reliable indicator of future performance.
* Yields for the Bloomberg U.S. High Yield Index, the Bloomberg U.S. Aggregate Bond Index, and Cash are yield to worst. Yields for the S&P 500 Index and the S&P 500 ex. Magnificent 7) are earnings yields.
† The “Magnificent 7” are Apple, Alphabet, Amazon, Meta, Microsoft, NVIDIA, and Tesla. The specific securities identified and described are for informational purposes only and do not represent recommendations.
Sources: Bloomberg Finance L.P. and Standard & Poor’s (see Additional Disclosure).

Even if we ignore the impact of the so-called Magnificent Seven technology stocks (which pull the S&P 500 earnings yield lower), high yield bonds still offer considerably more attractive levels of yield.

Conclusion

We believe the Fed’s recent dovish shift has increased the likelihood that a recession will be avoided over the near to medium term. If so, high yield bonds could prove more attractive than longer-term IG bonds over the next 18 months. As a result, our Asset Allocation Committee is maintaining an overweight position in high yield bonds.

Timothy C. Murray Capital Markets Strategist Multi‑Asset Division

Tim Murray is a capital market strategist in the Multi-Asset Division. Tim is a vice president of T. Rowe Price Associates, Inc.

Oct 2024 • From the Field

Cutting cycles and learning to love bonds again

By Sébastien Page

Sep 2024 • From the Field

How healthy is the U.S. labor market?

By Timothy C. Murray

¹ J.P. Morgan Chase North America Credit Research

² Yield to worst is the lowest possible yield on a bond if it is called before maturity.

Additional Disclosure

Bloomberg® and Bloomberg Indices are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by T. Rowe Price. Bloomberg is not affiliated with T. Rowe Price, and Bloomberg does not approve, endorse, review, or recommend its products. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to its products.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2024, J.P. Morgan Chase & Co. All rights reserved.

The S&P 500 Index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”), and have been licensed for use by
T. Rowe Price. Standard & Poor’s^® and S&P^® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones^® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). T. Rowe Price’s product is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.

Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Australia—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. For Wholesale Clients only.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

EEA—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.

New Zealand—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.

Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.

UK—This material is issued and approved by T. Rowe Price International Ltd, Warwick Court, 5 Paternoster Square, London EC4M 7DX which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.

202310-3946109

Open

Audience for the document: Share Class: Language of the document:

Open Cancel

Download

Share Class: Language of the document:

Download Cancel

Once registered, you'll be able to start subscribing.

Email address
First name
Last name
Company name

By clicking the Continue button, I acknowledge that I have read and accepted the Privacy Notice

Continue Back

Change Details

If you need to change your email address please contact us.

Subscriptions

You are ready to start subscribing.

Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS^® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the 27-year period ended June 30, 2023, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request.

Other Literature

You have successfully subscribed.

Notify me by email when

regular data and commentary is available
exceptional commentary is available

new articles become available