Investment grade credit | Insight Investment

Market environment

In July, US corporate spreads tightened by 7bp to +76bp option adjusted spread (OAS), delivering total returns of 0.07% and excess returns of 0.56%. The index yield rose 8bp to 5.07%, driven by higher Treasury rates. Top-performing sectors included independent energy, electric utilities, and refining, while health insurance, cable satellite, and chemicals lagged. ‘A’ rated bonds tightened 7bp, and ‘BBB’ bonds tightened 8bp. Credit curves steepened slightly, with intermediate spreads 7bp tighter and longer-dated spreads 6bp tighter.

European spreads narrowed 13bp to +79bp OAS, generating total returns of 0.53% and excess returns of 0.64%. Leading sectors were Life insurance, REITs, and electric utilities. Chemicals, pharmaceuticals, and food & beverage underperformed.

High yield spreads tightened 12bp to +278bp OAS, with total returns of 0.45% and excess returns of 0.59%. Lower-quality ‘CCC’ rated bonds outperformed, returning 1.47% versus 0.20% for ‘BBs’. The high yield index yield increased 2bp to 7.08%. Fallen angels totaled $2.4bn, with no defaults, and no rising stars.

The Federal Reserve held rates steady at its latest meeting. In what was the first dissent in over 30 years, two committee members voted for a rate cut. Inflation rose as expected, with the headline CPI at 2.7% and core CPI at 2.9%. Producer price inflation (PPI) declined. US non-farm payrolls slightly exceeded expectations, while average hourly earnings growth slowed to 3.7%, below forecasts. The ISM Manufacturing PMI improved modestly to 49.0, though new orders declined and prices edged higher. The University of Michigan consumer sentiment index rose slightly but remains below levels seen in late 2024.

Outlook

While the US has secured trade deals with the EU and some countries, many agreements remain unresolved, leaving tariff impacts on the economy and inflation uncertain. Forward-looking indicators are broadly neutral. We expect an economic slowdown following the stronger momentum in 2024 and early 2025, with GDP growth forecast at 1.4% in 2025 and 1.2% in 2026. Although recession is not our base case, it remains a clear risk, with labor market easing likely as activity softens. Inflation is trending downward gradually, with CPI expected just below 3% in 2025, easing to around 2.5% in 2026. Trade tensions have become background noise, with markets increasingly resilient, but the risk of a deeper downturn should not be dismissed. The Federal Reserve is expected to cut rates once or twice before year-end 2025, with further cuts in 2026, targeting a terminal Fed funds rate near 3.25% by 2026. We anticipate a modest steepening of the Treasury yield curve, with 10-year yields around 3.85% in one year.

Technicals

July investment grade corporate issuance totaled $67.5bn, the lightest month year-to-date and below estimates, partly due to lighter US bank issuance post-second quarter earnings. The average maturity of 8.9 years is the shortest since 2006, reflecting issuer preference for shorter duration amid a steep Treasury curve. In contrast, high yield issuance was the highest since September 2021 at $37.5bn. IG inflows remained strong at $29.7 bn. Treasury yields rose across the curve, with 5-year yields up 17bp to 3.97%, 10-year up 14bp to 4.37%, and 30-year up 12bp to 4.90%.

Fundamentals

Credit fundamentals remain robust. Earnings growth increased 9.1% quarter-to-date (66% reported), with 82.4% beating analyst expectations versus 77.6% last quarter. Financial leverage for investment grade issuers declined slightly, EBITDA margins are at record highs, and more companies are reinstating long-term guidance. Liquidity remains strong, supported by continued debt issuance despite April’s volatility spike.

Valuations

Investment grade spreads have fully retraced April’s tariff-driven widening (peak +119bp OAS), reaching new year-to-date tights of +76. While spreads are historically tight, yields near 5% offer an attractive entry point. Stable fundamentals and strong demand from yield-seeking investors should keep spreads range-bound near term, though tariff-related risks have increased in the second half of the year.

Risks

• Geopolitical risks
• Tariff-related impacts on growth and inflation
• Rising debt-funded M&A and shareholder distributions