The new cycle of rate cuts initiated by the US Federal Reserve comes at a time when conditions remain favourable for the US high yield market. With lower debt costs, supportive valuations and renewed M&A activity, the outlook for this segment remains bright.

On 17 September, the US Federal Reserve cut its key interest rate by 0.25% to 4% for the first time in 18 months. Markets are now anticipating key interest rates of around 3.75% at the end of 2025 and 3.00% at the end of 2026.

This new cycle of rate cuts will improve financing conditions for US companies directly on short-term debt but also on variable-rate borrowings (bank loans and floating rate notes).

Beyond this direct effect, what will be the impact of this new cycle of rate cuts on US high yield, both in terms of valuation and risk?

Improving financing conditions for high-yield companies

Firstly, the direct effect of lower short-term rates on the average cost of debt for US high-yield companies is significant: most US high-yield bonds are fixed-rate, so they are not directly affected by a fall in short-term rates, but most US high-yield companies also have syndicated bank debt (leveraged loans) on their balance sheets with coupons indexed to short-term rates. The outstanding amount of US leveraged loans, at over $2 trillion, is higher than the outstanding amount of US high-yield bonds, at $1.5 trillion.

These two markets interact and compete in particular to attract flows on the primary market: if loans offer issuers more favourable rates, the rates offered by high yield will also adjust downwards, either through direct demand for new paper or through a decline in the high yield pool in the face of continued strong demand (e.g. issuers refinancing bonds with loans, which reduces the high yield pool, etc.).

The strength of high yield bonds reinforced by the rise in equity markets

The second effect stems from the rise in the equity market during a period of falling interest rates. The revaluation of high yield companies' capital (either for listed high yield companies through an increase in market capitalisation, or for others through the revaluation of listed competitors) automatically increases the equity cushion below the debt and the coverage of debt by assets at market value. In this case, it is the risk of high yield that decreases and therefore deserves a lower risk premium, i.e. an increase in bond prices/decrease in yields.

Financing conditions conducive to a return to mergers and acquisitions

The third effect is an increase in mergers and acquisitions driven by better financing conditions thanks to lower interest rates: less expensive bridge loans, lower returns on bank deposits, which are shifting their capital allocation towards corporate financing, an increase in loans to private equity firms, etc. We are already seeing this effect at work in the market, with more than £1 trillion in mergers and acquisitions announced in the third quarter and the largest LBO in history planned with the acquisition of Electronics Arts for $55 billion (which would exceed the previous record set by US electricity company TXU in 2006 with $40 billion).

In conclusion, the Fed's upcoming rate cuts will support US high yield through the three transmission channels described above. The first makes high yield relatively cheaper, while the other two make it less risky as it is supported by rising company valuations. Even if the starting point is a market with high spreads (risk premium close to historic lows), the positive impact of these factors, which could prolong the period of strong performance in the US high yield market, should not be overlooked.

Completed on 03/10/2025

A new cycle of interest rates for the Fed: a new cycle for US high yield?

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