Will High-Yield Bonds Cool If Interest Rates Drop?

Federal Reserve head Jerome Powell's testimony to Congress has many investors wondering what is next. Powell has clarified that he is happy to see progress on the dual mandate: bringing inflation down without spiking unemployment. Inflation still appears to be on the right track, and many analysts believe we will see at least two interest rate cuts before the end of the year. The federal funds rate has been at 5.25% to 5.50% since last July. Any shift in this number will have repercussions across multiple areas. 

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There are many implications for this in the stock market, real estate, and other areas. One to consider is what will happen to high-yield bonds. High-yield bonds, also called junk bonds, have a rating of Ba1/BB+ or lower by credit rating agencies. This means that they have a higher risk of default. In theory, investors are rewarded for taking on more risk by receiving higher yields. These bonds may be particularly sensitive to economic and interest rate risk, which is why people are watching them closely right now.

A Recent Run-Up

Over the past several years, high-yield bonds have performed well, outpacing the broader bond market. That trend stabilized slightly in the first quarter of 2024, but high-yield bonds have retained their attractiveness for investors. High-yield bond funds, which package these bonds together, are a popular tool for investors.

One example is BlackRock's High Yield Bond Fund (BHYIX). As of this writing, it has a current net asset value of $7.04, a net asset value total return of 3.94%, and a one-year total return of 11.16%. It invests primarily in bonds with maturities of 10 years or less; over 80% of the assets are in high-yield bonds. Its trailing twelvemonth yield is 7.01%.

Another is the high-yield offering from Fidelity, Fidelity Capital & Income Fund (FAGIX). Its current net asset value clocks in at $9.98 per share with a one-year total return of 12.68%. Its strategy differs; it invests in equity and lower-quality debt securities and focuses on technology and U.S. assets. It has a trailing twelvemonth yield of 5.21%.

High-yield bond funds have very different compositions, so it’s important to do your homework before investing. While risk is common to all of these funds, the types of risk can vary from distressed company debt to investing in emerging markets worldwide. Because of this, the impact of the U.S. economy and any coming rate decisions may not be spread out equally across all high-yield bond funds.

Can you guess which type of investments Morgan Stanley says will reach $2.7 trillion by 2027? It even offers up to 20% APY potential to accredited investors.

Some Are Still Bullish On High Yield

Another important factor to consider when evaluating the future of high-yield bonds is the default rate. This has been lower than average recently, increasing confidence in high-yield bonds for many analysts and investors. One investor holding tight to high-yield bonds is Cyrus Amini, chief investment officer at Helium Advisors, who has seen a positive risk-reward ratio when investing in these funds. Similarly, earlier this year, State Street Global Advisors analysts noted that their models still showed strong potential for high-yield bonds even with higher interest rates forecast. 

If the past several years have proven anything, investment instruments don't always react how they are expected to or how we would like them to. However, the traditional wisdom is that when interest rates fall, bond yields will drop. 

When it comes to high-yield bonds and high-yield bond funds, it's important to truly understand your risk tolerance and to be comfortable with the idea that a higher default rate may return, which could drag on overall performance. Should we achieve inflation cooling without high unemployment and a slow path of interest rate reduction, that could be a positive sign. We don't know when interest rate cuts will come, nor can we fully forecast where the economy will go next. 

Looking For Higher-Yield Opportunities?

The current high-interest-rate environment has created an incredible opportunity for income-seeking investors to earn massive yields, but not through dividend stocks… Certain private market real estate investments are giving retail investors the opportunity to capitalize on these high-yield opportunities and Benzinga has identified some of the most attractive options for you to consider. 

For instance, the Ascent Income Fund from EquityMultiple targets stable income from senior commercial real estate debt positions and has a historical distribution yield of 12.1% backed by real assets. With payment priority and flexible liquidity options, the Ascent Income Fund is a cornerstone investment vehicle for income-focused investors. First-time investors with EquityMultiple can now invest in the Ascent Income Fund with a reduced minimum of just $5,000.

Don't miss out on this opportunity to take advantage of high-yield investments while rates are high. Check out Benzinga's favorite high-yield offerings. 

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