2023 Mid-Year Outlook: Corporate Bonds

We expect generally good performance during the second half of the year, although volatility may increase, especially for high-yield bonds.

Corporate bond investments generally performed well during the first half of the year. With higher starting yields, coupon payments were a key driver of returns, while a modest decline in intermediate- and long-term yields this year helped pull up prices, as well.

Performance in the second half of the year may be similar, but we continue to see a greater risk of price declines with high-yield corporate bonds. With the Federal Reserve expected to keep rates high for an extended period of time, potentially slowing down economic growth, we continue to suggest investors focus on high-quality investments.

For more conservative investors looking for income today, we prefer investment-grade-rated corporate bonds. For those investors who are willing to take more risk to earn higher yields, highly rated preferreds appear more attractive than high-yield bonds. If the economy slows, as we expect, high-yield bond prices may fall sharply, but the prices of preferreds issued by the large, highly rated U.S. banks may hold their value better.

Investment-grade corporate bonds appear attractive

Investment-grade corporate bonds still appear attractive for investors looking to earn higher yields without taking too much additional risk. Yields generally remain near their highest levels since 2009, with the average yield-to-worst (the lowest possible yield that can be received on a bond with an early retirement provision) of the Bloomberg U.S. Corporate Bond Index closing at 5.5% on June 16th. That index has an average duration—a measure of interest rate sensitivity—of seven years, meaning it has more interest rate risk than short-term investments. Over 90% of the index is made up of bonds with A and Baa credit ratings, so it has moderate credit risk.1

Investors who have been hesitant to consider more intermediate- or long-term bonds while the Federal Reserve was hiking rates still have the opportunity to earn yields that generally haven't been available since before the 2008-2009 financial crisis. In the five years leading up to that crisis, the index offered an average yield of 5.2%, lower than where it is today. In other words, aside from the surge in yields in 2008 and 2009 as corporate defaults were rising, yields are near their 20-year highs.

Investment-grade corporate bond yields are near 20-year highs