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Correlation between Treasuries and high-yield bonds no cause for alarm, says Rodilosso

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Correlation between Treasuries and high yield corporate bonds has been increasing in recent months, but that should not necessarily be cause for alarm, according to Fran Rodilosso, fixed income portfolio manager at Market Vectors ETFs.



“Historically, the correlation between high yield bonds and Treasuries has been slightly negative, as high yield debt has generally had a far higher correlation with equities,” says Rodilosso (pictured). “However, we are in somewhat uncharted waters at this point. I have never seen interest rates or absolute yields on corporate bonds so low.”

At current levels, high yield bonds are likely to be more sensitive to changes in Treasury yields than they have in the past, according to Rodilosso.

“Although I believe there will be greater sensitivity, I do not expect that there will be a one-to-one correlation,” he says. “Despite the all-time low yields in the high yield market, credit spreads are still closer to their historical average than to their lows. That relationship may suggest that high yield still has some cushion against rising Treasury yields, particularly under a slow growth scenario for the US economy.”

Rodilosso believes that a growing economy leading to moderately higher interest rates should be good for the health of high yield issuers.

“Moderately higher rates should not be too much cause for alarm,” says Rodilosso, “but there are some activities that I believe income investors should watch closely such as the amount of leveraged buyout (LBO) or merger and acquisitions (M&A) related-issuance, issues from first time or highly leveraged borrowers, dividend deals, and other signs which were less present in 2011 and 2012 that might indicate there is too much leverage in the market.”

As the Federal Reserve Bank continues to use unprecedented measures to maintain low interest rates, Rodilosso also believes that, at least for the time being, concerns about a near-term interest rate spike are most likely premature.

“There still appears to be room for a moderate move higher from present interest rate levels in the near term,” he says. “But, the risk over the long term is obviously heavily skewed towards an increase in interest rates, and the cost of protecting yourself against such a rise is currently fairly low.“
 

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