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Inflation Doesn't Necessarily Spell Doom For High Yield Bonds

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With interest rates hovering near historic lows, many have begun to ask what may happen when rates inevitably start to rise. Investors are starting to look at the fixed-income allocation within their portfolios with a nervous eye. Of course, when interest rates rise, bond prices generally decline. Because interest rates are so low, there is lots of room for them to rise.

It may be useful to explore the past relationship between high-yield bonds and their correlation to inflation over both a 5-year and 10-year history, if for no other reasons than to help us give reason to manage expectations. So, what does history show?

Going back to the beginning of 2010, high-yield bonds have had a correlation to the Consumer Price Index of just 0.43 and since 2015, they have had a correlation of 0.56. While a correlation of 0.43 is not a particularly strong one, the fact that it has increased over the 5-year time frame does imply some relationship.

High-yield bonds can be like equities, in that we believe they are often strongly linked to the businesses and corporations that they represent. In our opinion, this means that rising inflation rates and the potential for a corresponding increase in interest rates, won’t necessarily cause high-yield bonds to plunge, as there are other factors at play.

Chart: Correlation to inflation by Investment Class

US Consumer Price Index Urban Consumers Not Seasonally Adjusted, 1-month lag (CPI-NSA): A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services for the previous month.

Bloomberg Commodity Index (Commodities): A financial benchmark designed to provide liquid and diversified exposure to physical commodities via futures contracts.

S&P Global Natural Resources Index (Natural Resources): A measure that includes 90 of the largest publicly-traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified and investable equity exposure across 3 primary commodity-related sectors: agribusiness, energy, and metals & mining.

Bloomberg Barclays Capital US High Yield Index (High Yield): Measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

Dow Jones Global Real Estate Securities Index (Real Estate): Tracks the performance of equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded globally.

Deutsche Bank G10 Currency Future Harvest Index (Currency): Tracks the value of currency futures contracts on certain G10 currencies and is designed to exploit the trend that currencies associated with relatively high interest rates, on average, tend to rise in value relative to currencies associated with relatively low interest rates.

Bloomberg Barclays Capital US Treasury Inflation Protected Securities Index (TIPS-ALL): Measures the performance of the US Treasury Inflation Protected Securities (TIPS) market.

Bloomberg Barclays US Treasury TIPS 0-5 Year Index (Short Duration TIPS): Tracks the investment results of inflation-protected U.S. Treasury bonds with remaining maturities of less than five years.

S&P 500 Index (US Stocks): A market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.

Gold Spot Index (Gold): The price that traders pay for instant delivery of one ounce of gold.

Bloomberg Barclays Capital US Aggregate Index (Bonds): A broad base, market capitalization-weighted bond market index representing intermediate term (15 years of maturity and less) investment grade bonds traded in the United States.

US Dollar Spot Index (US Dollar): Measures of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.’s most significant trading partners.

S&P Global Infrastructure Index (Global Infrastructure): Designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability.


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