For investors, the US credit market offers a unique opportunity to diversify their portfolios, capitalize on a broad spectrum of credit instruments, and benefit from the stability and credibility that the US carries. Here, we explore why investors should consider US credit an essential component of their investment strategy in the current financial landscape.
Absolute yields are attractive
US investment grade (IG) credit absolute yields (yield to worst) are at 5.5%, a 10-year high. True, hedging costs for European investors have moved off recent lows. However, there are still attractive opportunities to allocate to US assets or incorporate them in existing credit portfolios. This is enhanced when combined with strong stock selection, which considers relative value and hedging impacts.
Chart 1. US corporate investment-grade bonds: Yield to worst
Source: Bloomberg, October 2023.
The US Federal Reserve is approaching an end to its rating-hiking cycle. With potential cuts in Q4 2023 and Q1 next year, the outlook for risk-adjusted returns is strong. The asset class presents a unique opportunity to receive extraordinary yields and capture the positive duration effects of rate cuts.
Shallow US recession mitigates downside risks
US economic data has been resilient, thanks to steady unemployment figures, strong retail sales, and stable corporate balance sheets. Nonetheless, we forecast a shallow recession for the latter stages of 2023. Inflation figures are beginning to show signs of rolling over, although remain a potential source of volatility.
While we expect volatility to increase in the coming months, US credit spreads have already repriced from 2023 lows. Against this backdrop, active security selection and attractive starting absolute yield levels should provide protection and good risk-adjusted total returns.
Chart 2. US corporate investment-grade bonds: Option-adjusted spread
Source: Bloomberg, October 2023.
Strong technicals in US IG
US IG primary issuance has already surpassed 80% of expected issuance this year, which the market has fully digested. Lower levels of issuance for the remainder of 2023 should support credit valuations. However, fund flows have been robust this year. As noted by J.P. Morgan, investors witnessed the 19th consecutive week of [investment-grade] inflows in September, bringing the year-to-date tally to $146 billion.1 Investor flows often follow total returns, and the recent shifts in interest rates have reduced total returns to below 1%, after reaching over 4% in July. Despite these changes, the market is demonstrating notable resilience. Lastly, estimates show US defined-benefit pension plans were around 103% funded as of May 2023. We expect a continued rotation into fixed income, particularly long-end corporate bonds.2
US allocation a priority across Europe
We’re also seeing strong demand from US and non-US investors, which should help mitigate spread widening in the event of a recession. Barclays recently highlighted new interest from the Middle East and China, on top of more traditional segments of EMEA and Asia-Pacific.3 Meanwhile, US allocation remains a priority among key fund selectors across Europe (Chart 3).
Chart 3. European fund selectors net investment intention
Source: Bloomberg, October 2023.
Final thoughts
With a strong history of fiscal responsibility, a wide array of investment options, and the backing of a resilient economy, US credit offers investors a safe haven amid global uncertainties. Even in today’s ever-changing investment landscape, the US credit market has historically provided a steady stream of income and a hedge against market volatility. We see no reason why this will change in the coming months.
1 J.P. Morgan "JPM Daily Credit Strategy & CDS/CDX am update." September 2023.
2 J.P. Morgan "Flows & Liquidity: US defined benefit pension fund de-risking flows likely to continue." June 2023.
3 Barclays "US IG Credit Outlook." October 2023.
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