This morning we saw the consumer price index climb the most in 10 months, up 0.4%. Not surprisingly, the biggest jump was in gas prices. The Fed may be telling us that these higher fuel costs are temporary, and whether you agree or not, these higher fuel costs are real and are having a real impact on consumers as the more they spend on fuel the less they spend elsewhere.
These higher costs also lead to questions/concerns about inflation: with costs rising and higher inflation, how does this impact the Fed’s ability to keep rates exceedingly low through 2014? Can they keep that promise or will their hand be forced to raise rates much earlier to combat inflation? The Treasury markets seem to be telling us that they have their doubts about the Fed’s ability to keep their low rate commitment, as over the last week or so, we gave seen Treasury prices taking a leg down and yields/rates making a sizable move up.
So what do rising rates mean for us as fixed income investors? The conventional wisdom in the bond world is that as rates rise, bond prices fall. While this does apply for Treasuries and investment grade corporates, this is much less of a concern in the high yield market, where we have historically seen much less interest rate sensitivity.
And just why is that the case? First and foremost, it is because high yield bonds have much higher coupon levels/yields, which cushion them against those rate moves. Additionally, high yield bonds have lower durations, a measure of interest rate sensitivity. High yield bonds have historically been much more linked to credit quality rather than interest rates. And finally, high yield bonds have historically been negatively correlated with Treasuries. As a point of reference, looking over the past 22 years, we have seen high yield bonds return 14.1% on average (or up 10.6% if we exclude the large move in 2009) during the years that the 5-Year Treasury rates rose.*
| Year | J.P. Morgan High Yield Bond Index Return | Change in 5 Yr Treasury Yield |
| 1980 | 4.3% | 2.21% |
| 1981 | 10.4% | 1.38% |
| 1982 | 36.3% | -3.82% |
| 1983 | 20.3% | 1.38% |
| 1984 | 9.4% | -0.46% |
| 1985 | 28.7% | -2.58% |
| 1986 | 15.6% | -1.68% |
| 1987 | 6.5% | 1.59% |
| 1988 | 11.4% | 0.73% |
| 1989 | 0.4% | -1.30% |
| 1990 | -6.4% | -0.15% |
| 1991 | 43.8% | -1.75% |
| 1992 | 16.7% | 0.06% |
| 1993 | 18.9% | -0.79% |
| 1994 | -1.6% | 2.62% |
| 1995 | 19.6% | -2.45% |
| 1996 | 13.0% | 0.83% |
| 1997 | 12.5% | -0.50% |
| 1998 | 1.0% | -1.17% |
| 1999 | 3.4% | 1.80% |
| 2000 | -5.8% | -1.37% |
| 2001 | 5.5% | -0.67% |
| 2002 | 2.1% | -1.57% |
| 2003 | 27.5% | 0.51% |
| 2004 | 11.5% | 0.36% |
| 2005 | 3.1% | 0.71% |
| 2006 | 11.5% | 0.38% |
| 2007 | 2.9% | -1.26% |
| 2008 | -26.8% | -1.89% |
| 2009 | 58.9% | 1.13% |
| 2010 | 15.1% | -0.67% |
| 2011 | 5.7% | -1.17% |
So while it is still too early to say if we are in a sustained period of higher rates, we don’t see that as a negative for high yield. While Treasuries, investment grade corporates, and municipal bonds will likely be impacted by higher rates, the high yield market’s lack of sensitivity positions it well as the place to be in the fixed income market.
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