New cycle tights

Key takeaways

• USD IG and HY corporate credit spreads have continued their march tighter, reaching new post-global financial crisis (GFC) era lows in recent days. In mid-October, we characterized the spread levels in the USD HY market as “warranted resilience”, owing to a range of positive fundamental factors and technical tailwinds. As we discuss within, relative to its USD HY peer, the recent tightening in the USD IG market is perhaps even more notable.
• So long as the U.S. growth backdrop remains supportive, we expect USD IG and HY corporate credit spreads to remain resilient, at the tight end of the historical range. We see a particularly compelling opportunity in Financials. One key risk we are monitoring is the potential for a “disorderly” move higher in U.S. Treasury yields (i.e., not a gradual rise, driven by better growth), which may deter yield-based buyers from deploying capital in corporate credit. Granular credit and sector selection will also be key, in our view, given the potential for significant policy shifts.
• As for monetary policy following the November FOMC, we see scope for another 25bp Federal Reserve (Fed) rate cut in December – reflective of a continued normalization of monetary policy. That said, uncertainty around the longer-term path is elevated. In early 2025, additional clarity on the FOMC’s view of the neutral rate will be increasingly important to differentiate between “normalizing” and “easing” monetary policy (we expect normalization).
• Because we are not expecting a significant rate cutting cycle, we place more emphasis on the income and carry (yield) components of USD corporate credit total returns, and less emphasis on the potential total return from duration exposure (which would benefit fixed rate bond total returns, mechanically, if/when rates decline). Floating rate exposures can offer an important element of portfolio diversification, in this regard.

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