KEY POINTS:
- With macro conditions uncertain, investors should adopt a flexible approach to fixed-income
- US high yield can bring both attractive total returns and naturally lower duration to fixed-income portfolios
- Moderating economic growth in the US should still prove supportive for most high yield companies
- Spreads are tight, but investors should consider low defaults rates and improving credit quality – the “junk” label no longer applies
The US high yield bond market delivered an 8.5% return in 2025, with coupon income contributing roughly 7% of the total.1 This despite the fixed-income environment becoming much more complex over the past year, with the macroeconomic factors that drive the asset class increasingly giving divergent signals.
While growth in the UK and Europe has been muted, the US economy has proved more resilient, with few signs yet of a meaningful slowdown – even while the labor market appears to be weakening. US trade tariffs and the Iran conflict’s impact on oil prices have further complicated the picture for inflation, meaning that the scope and timing of further cuts to US interest rates remains unclear.
Faced with such an uneven economic picture, fixed-income allocators must think flexibly and adopt an agile approach. This should allow them to capture return opportunities and diversify the risks that today’s macro cross-currents present to their portfolios. In this environment, US high-yield – which offers attractive natural coupon income and unique diversification qualities – can play a valuable role.
Why the current background favours US high yield
US growth is expected to remain resilient in 2026, but likely down slightly from the 2-3% GDP range over the past three years. This presents a favourable backdrop for the high yield market.
A mild slowdown over the next year or two may represent a “sweet spot” for high-yield issuers, providing a stable environment that should allow for revenue growth but without the extremes of a much hotter economy that can lead to excessive corporate exuberance, or recessionary environment that can instigate balance sheet deterioration and a pick-up in defaults.
The path for US interest rates is less clear. Above-target inflation, reinforced by higher energy prices, tariff pass-through and tighter immigration controls where diminishing spare capacity is putting upward pressure on wages, may constrain the Federal Reserve’s ability to cut rates after the upcoming change in leadership in May.
Despite recent rates volatility related to the jump in oil prices, however, the market is still pricing in further US rate cuts in the second half of the year. This would be generally favourable for bond market returns, including high yield. But even without cuts, current yield levels are still supportive for attractive carry-driven returns.
The magnitude of the impact on the US high yield market from the current military action in Iran will depend on the duration of the conflict and the severity of disruption to global energy supplies. Energy is approximately 11% of the US High Yield Index and should benefit from increased oil prices. We think the positive impact will be relatively subdued due to the already tight trading levels within Energy. A short-term active conflict and energy supply disruption which is measured in weeks is likely to have a very limited impact on US high yield earnings, average credit quality and default rates. A longer-term conflict with extended and significant impacts on global energy supplies is more likely to have a material impact on investor risk appetite, commodity prices, consumer behaviours and corporate earnings within multiple asset classes including US high yield.
The changing face of US high-yield
Whilst the macro environment remains somewhat complicated, at a micro level the US high yield market continues to prove resilient. Strong returns since 2023 have naturally attracted investor interest – helping partially to explain why high yield spreads are tight by historical standards.
However, today’s high yield spreads reflect more than just investor appetite for the asset class. Investors should also consider the sustained transformation in credit quality that has taken place in the US high yield market since the financial crisis of 2008-09.
Over this period, high yield has shaken off its “junk bond” reputation as the overall quality of the market has improved. The proportion of BB-rated bonds – the highest quality tier within high yield – is now at record levels at 59% of the market, versus 37% pre-crisis. CCC-rated bonds – at the lower end of the quality spectrum – have fallen from 16% to just 9%.2
This rise in average high yield quality has been further reinforced over the past few years by a rising share of secured bonds as one way that issuers have sought to minimise their interest costs in a higher rate environment. Secured issuance now makes up around one-third of the market, providing additional security to lenders and theoretically creating a lower ceiling to spread widening episodes in the market.
The net effect is a materially higher-quality index than the one against which historical spread comparisons are typically drawn. Given this substantial shift, comparing spread levels today with longer-term historical averages may be inherently flawed, even if recent ranges have certainly been expensive relative to any yardstick. Putting a number on what the “new normal” average high yield spread might be over the next 15 years is anyone’s guess, but there is a fair argument to suggest that it will be lower again than the previous 15 years.
Fundamentals and technicals remain supportive
The fundamental picture backs this improving quality narrative. Defaults remain below long-term averages, and while interest coverage ratios have come off their recent record highs as companies refinance at higher coupons, both coverage and leverage sit at manageable levels.
Meanwhile, issuers have continued to chip away at maturities, with 70% of gross new issuance in 2025 used for refinancing purposes. Net new supply therefore remains low even as gross issuance has picked up, and demand continues to outstrip it: US high yield mutual funds attracted $18 billion of net inflows in 2025, the highest since 2020. Chief amongst these sources of demand has been the roughly $280 billion of “rising stars” between 2022 and 2024 that migrated from high yield to investment grade, compared to only $40 billion of “fallen angels” moving in the opposite direction.3 This supply-demand imbalance has supported continued spread containment, even if we expect the technical picture to be more balanced moving forward due to less rising stars and increased AI-related and M&A driven supply.
AI disruption opens a new fault line in credit
The debate surrounding potential AI disruption for certain sectors has the potential to impact on future returns for high yield and global leveraged finance generally in 2026.
The AI-led sell-off in US equities in early 2026, driven by fears that AI could erode certain business models, presents both risks and opportunities for the high yield market. A more uncertain outlook for these businesses, especially software, has led to some repricing of their bonds as equity values decline, particularly among more highly leveraged companies.
What has not changed for now, at least for the high yield bond market, is that the numbers coming out of many of these software businesses in terms of earnings, revenues and EBITDA growth, are still very strong. This is different to previous sector-driven selloffs within high yield in the past (Telecom in 2001, Energy in 2015), when signs of balance sheet deterioration became increasingly apparent in the fundamentals of companies in those sectors in the lead-up to the selloff.
We believe that the market will eventually start to differentiate between potential winners and losers from the advance of AI. As this happens and fundamentals reassert themselves, dispersion in pricing will start to emerge in the high yield market, creating some attractive opportunities.
From a technical perspective, the high exposure that leveraged finance investors have to the software sector across bonds, loans and private debt warrants some caution. Here, it will be important to differentiate between the different levels of risk that are present across these markets. The area of BDCs and private credit generally has very significant exposure to Technology and software specifically – much greater than the high yield bond market. Some of these private credit managers will have less flexibility to adapt to AI risks in their portfolio than managers in the liquid high yield bond and loan markets. As for leveraged loans, 95% of software companies are rated B or lower, whereas 60%+ of high yield software companies are rated BB. From that perspective, the starting point for the high yield bond market is stronger on a relative basis than other leveraged finance markets, but the extent to which indiscriminate selling creates technical pressure across all credit markets warrants caution.
A distinctive role in fixed-income portfolios
The US high yield market has undergone a marked shift in quality since the 2008 crisis. Amid ongoing demand for higher yielding asset classes, we believe these shifting dynamics make a strong case for US high yield to become an increasingly common component of a standard asset allocation model, offering the potential for attractive income-driven returns that can compete with equities with lower volatility, whilst also complimenting longer duration fixed income assets, given its naturally shorter maturity profile.
[1] Source: ICE BofA US High Yield as of 31 December 2025.
[2] Source: BofA Research, ICE BofA US High Yield Index, as of February 28, 2026.
[3] J.P. Morgan Research Credit Strategy Weekly as of 31 December 2025.
At the time of writing 11/3/2026, the Middle East conflict has not warranted any major changes to our base case macroeconomic outlook or investment recommendations. To follow our analysis of the events driving asset markets, go to Viewpoint at https://viewpoint.bnpparibas-am.com
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