Originally published at: The case for investment grade corporate bonds – InvestEngine Insights
ETFs by J.P. Morgan Asset Management
1. Yields are attractive
Current investment grade (IG) yields are at decade-plus highs, with US IG companies currently offering yields of over 5%, and their European counterparts over 4%. Investment grade bonds are issued by the highest quality issuers, as rated by credit rating agencies such as Moody’s and S&P.
Fixed income yields
These yield levels help reduce downside exposure for longer-term investors. Spreads (the difference between IG yields and government bond yields) have tightened, and now sit broadly in line with long-run averages, reflecting the market’s expectation for higher-for-longer interest rates alongside a thus far resilient earnings outlook.
However, investment grade spreads have not tightened as much versus historical averages as spreads in the lower quality high yield market, particularly in the US. As a result, valuations in the higher quality segments of the credit market look attractive relative to their high yield counterparts.
2. End of interest rate rising cycle is generally a positive
Base rates in developed economies are elevated and we expect them to remain so for a fairly extended period. However, investors are increasingly confident that rate rising cycles are reaching a conclusion, both in the US and Europe.
Market expectations for central bank policy rates
While the path of the economy has varied after the last rate rise of a tightening cycle, bond returns have been fairly consistent, with high quality fixed income typically performing well. In particular, in the US a broad high-quality bond index has always outperformed cash over the two years from the last increase of the cycle (in every instance since the 1980s). Thus, a peak in rates should be a positive for higher quality fixed income.
3. Lending standards tightening, but fundamentals are resilient
Lending to companies has slowed over recent quarters as the impact of the central bank tightening cycles feeds through to the real economy. Banks have tightened lending standards in both the US and Europe, leading to a fall in corporate bank loan demand. However, lower financing needs and available internal funding were cited as reasons for this lower demand alongside higher interest rates.
US and eurozone lending standards
Corporate fundamentals look resilient, with ratings in both the US and European corporate sectors drifting higher. Firms have also been remarkably successful in pushing out maturity schedules, locking in the lower yield levels of 2020 and 2021. US non-financial IG firms have just 6% of debt coming due in 2024, and only 8% in 2025.
Investment grade corporate bonds: ETF building blocks
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