The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is doing relatively well this year, and is hovering at its all-time high as demand among investors jumped. HYG stock was trading at $81.23, up by 10% above the lowest level this year.
HYG ETF has flipped SCHD in total returns
Most notably, the HYG ETF has flipped the Schwab US Dividend Equity (SCHD) in terms of total returns. Seeking Alpha data shows that its total return this year was 7.3%, much higher than SCHD’s 2.38%.
Its performance this year has helped it to overtake the SCHD in its long-term gains. Its total return in the last three years is now 30% compared to SCHD’s 27%.
Falling interest rates and spreads
The HYG ETF has also attracted over $3.5 billion in inflows this year, bringing its total assets to over $18 billion. This surge is likely because of the significantly low default rate in the United States and the narrowing credit spreads.
The chart below shows that the delinquency rate of all commercial loans in the US stands at just 1.47%, down from the pandemic high of 1.67. It has also dropped sharply from its high of 7.50% during the global financial crisis.
Falling delinquency rates benefit the HYG ETF because it tracks high-grade companies, commonly known as junk. In this case, the primary risk for these companies will go bankrupt or start missing their payments.
The other reason why the HYG ETF is having substantial demand is that credit spreads are thinning. The chart below shows that the ICE BofA US High Yield Index Option-Adjusted Spread has been in a freefall, hitting 2.79% this month, down from the year-to-date high of 4.61%.
Credit spreads normally surge in periods of high volatility or when investors expect higher default. In this year’s case, the surge happened after Donald Trump started his trade war, leading to a significant increase in recession risks. These fears have now abated after he inked deals with many countries. Two US courts have also ruled that his tariffs were illegal, a case that the Supreme Court will ultimately determine.
Federal Reserve interest rate cuts and recession risks
The main catalyst for the HYG ETF is that the Federal Reserve has started to cut interest rates. It slashed them by 25 basis points on Wednesday, and the dot plot pointed to two more this year.
The Fed has largely ignored the stubbornly high inflation rate and is focusing on the labor market. Recent data showed that the economy created just 22,000 jobs in August as the unemployment rate rose to 4.3%.
At the same time, the country’s inflation continued rising, with the headline figure rising to 2.9% and the core inflation rising to 3.1%.
Therefore, analysts expect that the new rate cuts will help to prevent a recession in the next 12 months. In a recent note, Mark Zandi, the chief economist at Moody’s, warned that recession odds stood at 48%.
Technicals suggest that the HYG ETF has more upside this year. It has remained above the 50-day and 100-day Exponential Moving Averages, while the Average Directional Index has jumped to 34, a sign that it is strengthening. If this happens, the next key level to watch will be at $100.
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