US High Yield: embracing credit divergence and unlocking opportunities

During 2025, the pendulum swung significantly on the macro environment: a lot of enthusiasm at the start to the more draconian situation that markets priced in during April. The market eventually shrugged off any concerns about tariffs, the labour market and the longest government shutdown in history to generate an 8.5% calendar year return¹ although jitters over certain default stories in lower rated pockets of leveraged finance created some notable decompression in the last quarter.

This sets the scene for what is likely to be one of the main talking points for credit investors in 2026 – to what extent is widening dispersion across quality segments of the market reflective of a deteriorating credit market and, in this healthy coupon-clipping environment with spreads seemingly stuck close to all-time tights, should we care?

At the macro level, despite a lot of noise geopolitically, 2026 has started on a relatively sound footing for the US economy – with fears over a deteriorating labour market subsiding for now. We are expecting growth to be slower over the next couple of years, but to still be underpinned by resilient fundamentals, which is supportive for US high yield issuers’ ability to grow earnings in a steady environment.

Although the Fed looks likely to be on hold for now, above-target inflation could hinder the ability of the FOMC led by new Fed Chair nominee, Kevin Warsh, to resume rate cuts when he takes up office. We saw during the recent Greenland episode that tariffs are still a favoured mechanism to generate bargaining power, whilst existing tariff pass-through, falling labour supply from tighter immigration, and AI-related exuberance should keep inflation sticky. Nevertheless, the market is still pricing a couple of rate cuts in the second half of the year which, if realised, should continue support all fixed income markets.

Spreads – cause for concern or fairly priced?

In January, credit spreads were peculiarly resilient despite rising geopolitical tensions and the renewed threat of US tariffs on key European trading partners. This begs the question as to whether investors are now looking through some of the rhetoric out of the US administration, or whether there is something else – potentially structural – at play. We argue that whilst spreads are clearly not cheap by any historical comparison, when considering the longer-term trend towards a much better-quality high yield market, we should think about spreads increasingly on a “quality-adjusted” basis. Investors might still think of the high yield market as the “junk bond” market, yet what we've seen over that last 15 years is the market gradually moving up in quality. Today, we have 57% BBs compared to 37% before the global financial crisis and 12% CCCs compared to 16% before the global financial crisis².

Alongside this, there has been a higher level of secured bond issuance in the past few years of higher rates, as a way for issuers to minimise interest expense, creating a higher floor to sell-offs. Despite being a naturally shorter maturity part of fixed income, the US high yield market’s duration is today touching record lows due to bonds staying outstanding longer as many companies have been able to wait for rates to come down before refinancing, whilst ~$280bn of rising stars in 2022-24 took out some of the more rates-sensitive part of the market, which has not been replaced by fallen angels (~$40bn over the same time period).³ So, structurally, the market should justify a tighter spread level and should lead to a lower ceiling in spreads when we see sell-offs, which is what we saw during ‘Liberation Day’.

Current fundamental and technical dynamics are also supporting tight spreads, with defaults still below long-term historical averages. We have been coming off record-high levels of interest coverage and record-low levels of leverage for US high yield issuers, with some mild deterioration in both metrics as companies have refinanced at higher rates, but still both very manageable.

Maturities also continue to be pushed out, with 70% of 2025’s gross new issuance used for refinancing purposes as companies took advantage of declining yields in the second half of the year.⁴ Whilst we’ve seen a pick-up in gross new issuance, net supply continues to be low and strong demand for paper has continued into January. Investors have responded to these positive dynamics with +$18bn of net mutual fund flows into US high yield in 2025 – the highest since 2020⁵.

This backdrop points towards further containment in spreads, although we expect that spreads may finish 2026 in a slightly wider trading range than what we have today with increased bifurcation across sectors and ratings, driven by volatility related to AI-disruption risk and further decompression in the lower rated part of the market.

What opportunities are there across the investment landscape?

With uncertainty around the long-end of the curve due to fiscal pressures and potential contagion from the situation with Japanese long-end yields, we believe that shorter duration asset classes like high yield offer a natural buffer.

In particular, we continue to find potentially attractive risk/reward opportunities in short duration high yield. Capital availability to address near-term maturities has rarely been higher, with financial solutions offered even to stressed companies. In our view, “security by maturity” persists in many capital structures due to the abundant supply of capital available in credit markets. Short duration also protects against spread volatility, provides liquidity, and offers an appealing yield capture versus full duration counterparts.

Whilst there are plenty of high yield bonds still trading below par, there is also a good amount of bonds above par that are trading to short call dates, generating a lower yield-to-worst. Together with our analyst team, we aim to identify bonds that we believe will stay out longer than is priced, thereby generating a higher realised return than the yield-to-worst today (i.e. “extension trades”).

On the primary market, banks expect issuance to be up again this year, driven by increased M&A/LBO activity and AI-related issuance, with some forecasts pointing towards at least $15-20 billion of AI-related issuance in US high yield to fund data centre buildouts⁶. However, relative to investment grade we expect high yield AI-related issuance to remain quite muted for now, given the comparably higher cost of capital and more flexible options available to fund deals in private credit.

In January, we saw multiple compression in equity markets within the tech/software space spill over into indiscriminate selling of software names within public and private credit markets, driven by fears that AI could threaten these companies by disrupting their workflow or rendering them redundant entirely. This presents both a significant risk and opportunity for the US high yield market and leveraged finance generally in 2026. The uncertainty surrounding some of these businesses has reduced the amount of equity cushion behind the bonds, so some repricing on the bonds seems to be justified, particularly in higher levered names. However, we think at some stage the market will start to differentiate between potential winners and losers in the space and the fundamentals will start to drive more dispersion in the sector over time, leading to some great opportunities.

Given the decompression we have seen in recent months, triple-Cs are experiencing a lot of dispersion. For higher return seeking strategies, in a tight trading environment we are focused on trying to identify the best ideas within the higher yielding segment of the market, although we remain quite defensively positioned relative to history, poised to add risk on any market weakness

Finally, whatever 2026 has in store, it’s worth remembering that there are different ways in which you can use US high yield, not only to reflect different outlooks and risk appetites, but also to complement other asset classes. One of the major benefits of US high yield is its diversification quality: being able to produce equity-like returns, but with much lower volatility, while having a shorter maturity than investment-grade. It can also complement high-quality parts of fixed income. So, it may play a unique role in a diversified portfolio.