Global corporate bond spreads are poised for their first month of widening since late last year, reigniting discussions about the relative value of credit compared to other fixed-income assets as we move into the latter half of 2024.
In June, spreads on corporate bonds, encompassing both high-yield and investment-grade notes, have widened by approximately 10 basis points from the lowest levels seen in three years, according to a Bloomberg index. Meanwhile, yield premiums on these bonds and US high-grade bonds are rebounding from levels reached in May that were historically low, seen only about 1% of the time since the 2008 financial crisis.
Despite the spread widening, which could make corporate credit less appealing compared to Treasuries, Goldman Sachs strategists led by Lotfi Karoui don’t anticipate significant widening. They project US high-grade spreads to close 2024 at 90 basis points and junk spreads at 291, compared to current Bloomberg index levels of 94 and 314 basis points, respectively.
Neeraj Seth, chief investment officer and head of Asia-Pacific fundamental fixed income at BlackRock in Singapore, describes the macroeconomic backdrop as “not too hot, not too cold,” a scenario typically favorable for credit. Although spreads may fluctuate, there is potential for tightening over the next six to nine months, he noted.
Luke Hickmore, an investment director at abrdn, acknowledges that investors aren’t being heavily compensated for credit risk. However, he believes holding corporate debt remains justified since spreads could stay at current levels for several years, similar to the 2004-2006 period when interest rates were high. “Fundamentals are solid,” he said, pointing out that many companies have reduced their debt levels. With deleveraging, a stable economic outlook, and high interest rates, he argues that the extra carry is worth it.
A decline in US Treasury yields this month, driven by renewed expectations that the Federal Reserve will cut interest rates at least once this year, has contributed to the widening of credit spreads. Corporate bonds typically lag behind more liquid government debt in reflecting these changes.
JPMorgan Chase strategists Eric Beinstein and Nathaniel Rosenbaum noted that historically, spreads struggle to tighten when yields are declining until they stabilize. This pattern could deter some investors, as observed earlier in the month.
For some investors, the issue with corporate credit lies more in its modest yield premium relative to its risks than in any clear signs of economic weakness or corporate balance sheet problems.
Noah Wise, a portfolio manager at Allspring Global Investments, has reduced his exposure to high-yield bonds amid the recent rally. He prefers US agency mortgages with AA ratings and spreads in the 50s, citing unattractive valuations in the current credit market. “There’s a historically narrow spread for credit risk now, so we’re lightly positioned,” he remarked.
Despite this month’s setbacks, corporate bonds have outperformed Treasuries so far this year, a trend expected to continue. Goldman strategists forecast that high-grade and high-yield bonds in dollars and euros will outperform government bonds throughout the year.
Goldman predicts European junk bonds could deliver 5% in excess returns in 2024, with US equivalents generating 3.7%. European and US high-grade securities may deliver 2.7% and 1.6%, respectively. In the US high-yield debt market, metrics have been mixed, with profit margins dropping to a three-year low in the first quarter, although leverage remains below the long-term average, according to JPMorgan strategists.
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