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Fixed Income
Valuations are expensive, but may have staying power

Demand for investment-grade corporate bonds remained robust during the first quarter despite a heavy new issuance calendar. Spreads for the Bloomberg US Corporate Investment Grade (IG) Index tightened by 9 basis points (bps) to finish the quarter at 90 bps.

Bloomberg US Corporate Investment Grade Index

Investors have largely priced out recession scenarios

Data as at 31 March 2024. Figures reflect option-adjusted spreads and yield-to-worst. Sources: Bloomberg, Bloomberg Index Services, Ltd

The economic backdrop has been supportive for spread tightening. The Federal Reserve Bank of Atlanta’s GDPNow forecasting model projected first-quarter GDP growth of 2.3% at the end of March. Meanwhile, the Citi Economic Surprise Index remained above zero for the entire quarter, indicating that most economic reports came in above expectations. This helped to push US Treasury yields higher and signalled a constructive environment for companies.

New issuance of IG corporate debt in January and February were the sixth and fifth highest on record, reaching US$194 billion and US$196 billion, respectively, according to data from JPMorgan. In February, 75% of new supply was from non-financial companies. Companies also increased issuance of 30-year and longer maturities.

IG corporate spreads are trading below their long-term average, with spreads on BBB-rated bonds relative to their A-rated peers compressing more than 20 bps below average. This has some investors concerned about the potential for spread widening in the event the US does experience a traditional economic cycle, including a recession sometime in the next six to 18 months. History indicates that if a traditional cycle unfolds, spreads may not widen until well after the Fed begins to cut rates. In addition, the IG corporate sector’s nearly seven-year average duration has supported returns in the past as interest rates declined. The Fed signalled in its March meeting that it expects to begin cutting interest rates later this year. In the past three recessions (which includes the 2020 COVID recession), the peak in spread widening occurred an average of about 15 months after the Fed made its first interest rate cut. Thus, while spreads are trading well below their long-term average of roughly 130 bps, this environment could persist for some time.

IG spreads typically peak well after the Fed begins to cut

Investors have largely priced out recession scenarios

As at 31 March 2024. Index reflects the Bloomberg US Corporate Investment Grade Index. Mos: months. Sources: Bloomberg, National Bureau of Economic Research

Relative value opportunities are available across the IG corporate market. Recent new issuance from the pharmaceutical sector to support M&A transactions that expand drug research capabilities and pipelines have given investors an opportunity to invest in high-quality companies that are committed to reducing leverage over the coming years. The utility sector also has several issuers with improving fundamentals that could help to push spreads tighter relative to the corporate basis. Finally, while spreads for banks continued to tighten relative to the IG index during the quarter, relative value opportunities persist for major banks and large super-regionals. 

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