Defensive Stand: Investment-Grade Corporates Hold the Line

The financial markets are giving off mixed signals of late, and credit investors may wonder whether to be downbeat or optimistic. After all, Europe has emerged from a mild winter with none of the calamitous effects expected of its divorce from Russian energy, gas, and oil, and most eurozone economies are expanding—albeit slowly. In the US, job numbers continue to impress, and a dreaded recession remains more rumor than reality after two years of doomsday predictions.

Still, corporate bond investors remain wary, and for good reason.

Macro Backdrop Is Tenuous

Despite strong news on the jobs front, the global growth outlook is uncertain—particularly given concerns around midsize and regional banks and an inverted Treasury yield curve hinting at recession. Although we believe that recent banking turmoil is largely idiosyncratic rather than systemic, there’s little doubt that banks will need to be more cautious in extending credit, and we’ve lowered our growth forecasts accordingly.

Stubborn global inflation is also an issue. With the European Central Bank nearing the end of its rate-hike cycle and the fed funds rate north of 5%, we expect inflation across most developed markets to continue moderating. Still, it could take another year before it falls to the Federal Reserve’s long-range target of 2%, and we’re not nearly as dovish as some market participants about rate cuts in the second half of 2023. In both Europe and the US, housing, and wage inflation still warrant monitoring.

Given these macro-level crosswinds, is it too risky to invest in corporate bonds? We don’t think so, based on fundamentals, valuations, and technical factors. But investors need to be selective.