NEW YORK, March 7 (Reuters) - Bank of America Merrill Lynch analysts said on Tuesday they see a "new phase of euphoria" for the U.S. junk bond market as persistent demand will likely reduce risk premiums in the sector in the coming months.
They, however, cautioned investor optimism for high-yield bonds could flag in the second half of 2017.
"We do think we are entering a new phase of euphoria that, dare we say it, leads to indiscriminate beta compression circa 2014," Bank of America Merrill Lynch analysts said in a research note published on Tuesday.
They noted back in 2014, junk bonds' risk premiums or yield spreads versus Treasuries contracted as the Federal Reserve began its tapering of bond purchases under its quantitative easing program.
Last week, several Fed officials said the U.S. central bank is considering a faster pace of interest rate hikes in 2017 as the economy is approaching full employment and inflation is closing in on the Fed's 2 percent goal.
Investor confidence about faster U.S. growth was buoyed following U.S. President Donald Trump's speech before a joint session of Congress a week ago.
On the following day, the Dow crossed the 21,000 level for the first time, while the S&P 500 reached historic highs.
The average yield spread on junk bonds narrowed to 360 basis points on Friday, albeit still wider than its record tight of about 235 basis points, according to Bank of America Merrill Lynch analysts.
They said the sector's rally will likely continue to the riskier bonds issues with those rated CCC or lower.
Bank of America Merrill Lynch's U.S. high-yield bond index has gained 2.817 percent year-to-date.
"Although we think the optimism has likely gotten ahead of itself, we do think the bid for yield and risk continues for the next several months," the analysts wrote. (Reporting by Richard Leong; Editing by Chizu Nomiyama)