Investment grade credit | Insight Investment

Market environment

US corporate spreads were 12bp wider in April at +106bp option adjusted spread (OAS), producing total returns of -0.03% and excess returns of -0.62%.

The last time spreads had widened by over 12bp was in March 2023. The strongest sectoral performance was from banking, consumer non-cyclical and capital goods sectors. The worst-performing sectors were energy, basic industry and REITs. A rated corporate bonds were 9bp wider and BBB were 17bp wider on the month. Credit curves flattened with intermediate spreads 15bp wider and longer dated spreads 7bp wider. Long-end credit spreads held in better as the Treasury curve continued to steepen.

European corporate spreads were 14bp wider on the month at +112bp OAS producing total returns of 0.99% and excess returns of -0.57%. The best performing sectors were electric, natural gas and banking, while the weakest sectors were life insurance, diversified manufacturing and integrated energy.

High yield spreads were 37bp wider at +384bp OAS, producing total returns of 0.02% and excess returns of -1.00%. Higher quality outperformed with BB rated debt returning +0.13% versus CCCs declining by -0.75%. The yield on the High Yield Index increased by 17bp during the month to 7.90%. There were $1bn in fallen angels (GFL Environmental), $5.3bn in rising stars (UniCredit Spa, Intesa Sanpaolo), and no defaults during the month¹.

In the US, many commentators and market participants raised the prospects for a recession hitting the US following President Trump’s announcements of widespread and extensive tariffs. Perhaps unsurprisingly, forward-looking data softened notably in April. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) declined sharply and by more than had been widely expected. The Business Optimism Index from the National Federation of Independent Business fell for a third consecutive month, though it remains above the levels seen across most of the 2022-2024 period. The University of Michigan Consumer Sentiment measure declined significantly once more and is now challenging the lowest levels in the past ten years, which were reached in mid-2022 as headline inflation had moved above 8% and the war in Ukraine was continuing to escalate. For the month, headline inflation fell back to 2.4%, the lowest level in more than four years, with the core rate falling below 3% for the first time since March 2021. Interest rates remained unchanged as there was no Federal Reserve rate setting meeting in April. 

Outlook

In the wake of the US tariff announcements, markets have begun a major reassessment of where the US economy may be expected to go. While one of the key hopes and intentions is to create a significant incentive to reshore manufacturing capabilities to the US, we believe there is likely to be a material slowdown in activity, potentially into recessionary territory. US inflation is expected to remain above target and could face renewed upward pressure, particularly if trade tensions escalate. However, we believe it should continue to trend lower over time as the tariff effects on imported goods may only have a transitory influence on prices. We retain our 12-month forecast for 10-year US Treasury yields at 3.90%. We believe the Federal Reserve will slowly ease policy rates over time, taking Fed funds to about 3.75% in 12 months’ time, despite coming under political pressure to cut rates more quickly. We see a neutral/terminal rate around 3% - 3.25% for the US, with a skew of risks being lower than that if activity declines sharply. 

Technicals

Investment-grade corporate issuance was $96bn in April, which was below initial expectations as more issuers opted to wait on issuance because of the market volatility. Average maturity for investment-grade new issues was 7.4 years, the lowest since July 2023, as issuers opted for shorter issuance as the treasury curve steepened. Banks are also regular issuers in April, following the first quarter earnings announcements, and they tend to issue in the front end. Flows into investment-grade credit funds turned negative over the past three weeks, driven by increased market volatility. Yields remain historically attractive over 5%, so we expect recent outflows to moderate. In April, the treasury yield curve steepened again, driven by growth concerns and the market pricing in more near-term rate cuts. The 5-year Treasury yield declined by 22bps to 3.73%, 10-year was 5bp lower to 4.16%, and 30-year was 11bp higher to 4.68%.

Fundamentals

First-quarter earnings for S&P 500 companies have increased 12.5% year-on-year (392/500 reported), with 76.3% beating analyst forecasts. Fundamentals remain strong, but more companies have been withdrawing or lowering guidance because of the increased uncertainty related to tariffs. Liquidity profiles remain very strong as companies have still been able to issue new debt despite the recent spike in volatility. M&A could increase under the current political administration, which could put pressure on credit metrics in the second half of the year.

Valuations

Investment-grade spreads have been widening because of the uncertain tariff impact and its impact on growth. Spreads reached a new YTD high on April 8^th at +119bp and are currently 24bp wider YTD. Currently, we believe spreads are more fairly valued as risks have been increasing for a global trade war. Yields in credit remain attractive over 5%. Our expectations for stable fundamentals and strong demand from yield buyers should keep spreads trading in their current range in the near term, although longer-term risks have increased with new tariff announcements.

Risks

• Geopolitical risks
• Negative impacts from announced tariffs on growth and inflation
• Increase in debt-funded M&A and shareholder returns