Contagion Could Drive Opportunity in Municipal High Yield

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Contagion Could Drive Opportunity in Municipal High Yield

Christine Todd, CFA

Christine Todd, CFA - President of Standish and Head of the Tax-Sensitive and Insurance Strategies

As we entered the final weeks of 2015, the US high yield (HY) market struggled with destabilizing undercurrents, including: the downbeat OPEC meeting, which drove oil prices to new 5-year lows; the Federal Reserve’s recent rate increase, which created uncertainty; and recent news of liquidating distressed hedge funds and freezing mutual funds, which exacerbated concerns about trading liquidity. As the corporate high yield market seeks to establish fair valuation and orderly trading, we expect price erosion to abate, particularly with HY yields currently trading near 9%. In prior periods of rising rates, HY spreads have tended to trade tighter within the ensuing six months; we would expect this trend to persist. Nevertheless, the Energy and other commodity linked sectors are likely to see default rates rise to around 4.0%, which is an increase from 2.5% in 2015, but still lower than the historical average rate of 4.7%. We expect energy will continue to be a drag this year, currently trading at approximately 14% yields, with dollar prices generally hovering in the mid $60s.

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