Fixed income perspective – from the Investment Advisory Group

Expect further pressure in corporates, especially high yield

• U.S. corporate bond spreads (i.e., the additional yield corporates offer over like-maturity U.S. Treasury yields), started the year close to their long-run averages. At that time, we stated credit spreads failed to sufficiently compensate investors for rising economic risks.
• This month, heightened concerns around the stability of the banking sector and hawkish Fed policy fueled a sharp widening in U.S. credit spreads as investors exited riskier fixed income in favor of higher quality substitutes. Credit spreads for both investment grade and high yield corporate bonds have moved above their 10-year averages but far below recessionary levels.
• Rapid Fed rate hikes in response to inflation and higher intermediate yields are contributing to pockets of stress within the banking industry. In general, we expect lending standards to continue tightening and create a meaningful headwind for growth as we move through the year.
• Over the past two years, the Fed’s hawkish policy stance and the significant rise in U.S. interest rates have dramatically increased borrowing costs for U.S. companies. This month’s widening in credit spreads have amplified those costs and slowed U.S. companies’ new debt issuance to a crawl.
• During periods of uncertainty and rate volatility like we have endured in March, new issuance of corporate debt tends to fall meaningfully. This limits corporate issuers’ access to cash and can create liquidity challenges. We expect this dynamic to continue in the very near term.
• Given today’s tight credit spread levels relative to prior periods of rising economic risk, we maintain our underweight bias in U.S. credit, especially below investment grade-rated sectors such as high yield corporate bonds and leveraged loans. We believe the riskiest fixed income sectors remain susceptible to relative underperformance versus high quality fixed income ahead of slower economic activity.
• We would use any spread tightening as an opportunity to lighten overweight credit exposures, particularly among lower-rated sectors. Within investment grade corporates, we maintain an up-in-quality bias; AA- and A-rated corporate issuers currently offer a more compelling risk-reward profile than the lowest-rated tiers of investment grade debt.

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