Banks expect higher-rated bonds to beat junk debt for first time since 2020
Investors position for rate cuts and slower economic growth
by Olivia Raimonde · Financial PostJPMorgan Chase & Co. and Morgan Stanley expect U.S. investment-grade bond returns to beat speculative-grade debt in 2024 for the first time in four years as investors position for interest-rate cuts and slower economic growth.
Bank of America Corp. recommends higher-rated bonds over junk debt as it sees rates, earnings and issuance challenging credit this year.
Fixed-rate debt — what investment-grade companies typically issue — is more sensitive to interest-rate hikes, and investors holding such bonds should benefit from the United States Federal Reserve lowering borrowing costs this year. At the same time, a slowing economy could weigh on the performance of lower-rated debt, a scenario that Morgan Stanley expects this year.
“It comes down to the macro environment,” Morgan Stanley strategist Vishwas Patkar said. “We think the economy will see a soft landing, but that happens with bumps along the way.”
He sees a better upside for returns coming from shorter-dated debt such as five-year bonds rather than longer-duration credit, which benefited from a rally in December and has limited upside now.
Globally, investment-grade debt struggled to advance in 2023 until a rally beginning in November catapulted returns nearly 10 per cent, the biggest two-month jump on record. Before that, the prospect of interest rates remaining higher for longer dampened performance, while stronger-than-expected economic growth pushed returns for both high-yield bonds and leveraged loans to 13 per cent. The story could be different in 2024 as growth wanes and investors price in rate cuts.
“Continued compression in Treasury yields as a result of weakening macroeconomic conditions will facilitate strong duration-related returns, if realized,” Noel Hebert, credit strategist for Bloomberg Intelligence said in a December report.
He expects investment-grade bonds to hand investors gains in the mid- to high-single digit range.
Still, not all companies are bullish about high-grade debt. BlackRock Inc. is underweight global investment-grade credit, citing tight spreads that “don’t compensate for the expected hit to corporate balance sheets from rate hikes.”
Mitsubishi UFJ Financial Group is less optimistic about credit altogether. Its strategists warn that a potential downside could be substantial in the case of a “bumpy landing” and recommend that money managers wait to invest in U.S. fixed income.
“Even if we get large rate declines, as we expect, credit spreads and risk assets are pricing perfection,” strategists including George Goncalves said in a report in December. “From current levels, we see limited upside in total returns from pure-play credit products.”
But for institutional asset manager Robeco Holding BV, uncertainty around the possibility of a recession later this year strengthens the case for investment-grade credit over high-yield debt.
“With overall yields in investment-grade credit still at attractive levels and with good return prospects, the asset class can compete with many other more risky classes,” Robeco’s Sander Bus and Reinout Schapers said in a report.
— With assistance from Jill Shah and Dan Wilchins.