High-yield credit holding up well in face of volatility

Despite recent volatility, some of the riskier elements within fixed income have held up surprisingly well, says Siena Sheldon, vice president, client portfolio manager with Brandywine Global Investment Management.

Sheldon said there have been some unexpected effects as the fixed-income market recalibrates in the wake of tariff confusion and commotion.

“While credit spreads have widened at times, yield cushion and strong fundamentals have really helped cushion some of that impact,” she said. “So, really, high-yield credit has held up better than we would have expected.”

At the same time, however, some generally safer investments — like U.S. Treasuries and the U.S. dollar — haven’t behaved as expected this year.

“Longer-term yields in the U.S. did move up in some of that risk-off sentiment that we’ve had, and that’s partly because people are nervous about U.S. fiscal deficits,” she said.

“The dollar, another traditional safe haven, has also been taking a hit as investors really start to rebalance portfolios away from U.S. assets, which they have been structurally overweight to for a very long time.”

Speaking on the Soundbites podcast, Sheldon said she now favours higher-yielding, shorter-duration bonds.

“In this environment, you really want to manage interest rate risk and spread volatility,” she said. “Rates are really going to continue to be volatile, so you want to stay underweight duration. Specifically, we like shorter-dated high yield, as it offers both yield cushion and that pull-to-par dynamic.”

She also likes mortgage-backed securities.

“These offer great yield and have a higher quality skew, and also have credit risk that’s differentiated from corporate credit as it’s more tied to the U.S. housing market, which is still in structurally low supply.”

She remains cautious of the U.S. dollar, expecting the next couple of months to tell a story of global growth convergence.

“That should weaken the dollar,” she said. “And, in light of that, emerging market debt should do well.”

As for interest rates, she said the U.S. Federal Reserve is in a “tough spot” with potential stagflation looming. And the picture is complicated by tariffs pushing input costs up, and potentially acting as a drag on demand and consumer sentiment.

“You have slowing growth on the one hand and somewhat sticky inflation on the other.But Powell has remained pretty consistent in saying that the Fed will act based on data,” she said. “Our base case for now is that they will hold rates until we get a read through on some of these tariffs. With policy rates already restrictive in real terms, there’s really no urgency to move, especially if employment holds up.”

In Canada, the consensus is there will be one to two additional rate cuts by year end, which would keep the spread between the Fed and the Bank of Canada at around that 150 to 175 basis points.

“Even with tariffs, we’re not expecting the Bank of Canada to diverge significantly beyond that spread level,” she said.

Overall, headline sensitivity remains high, she said, and volatility will likely continue as the tariff picture continues to evolve.

“Bottom line right now, keep it shorter duration or underweight duration, stay selective and focus on gathering income,” she said.

Treasury yields are caught in a push-pull between growth risks and price pressures, she said, and unless the U.S. falls into a deep recession, we are unlikely to see U.S. yields break meaningfully lower.

“Shorter-dated higher-coupon credits offer solid income, help cushion against moderate spread widening and have less exposure to rate volatility,” she said. “This is going to continue to be a headline-driven market, so clipping coupon, doing the bottom-up credit work and being nimble in volatility is going to be key this year.”

**

This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.