Spread widening in credit could raise cash’s appeal

After months of tightening, credit spreads look tight compared to their historical ranges, especially for US investment-grade (IG) corporate bonds. In a context of high-for-longer Fed policy rates and our expectation for a deceleration of nominal GDP growth in the US in H2, the fundamentals of IG corporations in the US could deteriorate gradually. At the same time, spread widening could be relatively more limited than we previously expected as we no longer expect a recession in the US this year while our base scenario now is for two Fed rate cuts in H2.

Euro IG does not look as expensive, with spreads remaining close to their historical median. Moreover, after a shallow recession in H2 23, non-financial companies’ fundamentals could be supported by the ongoing economic recovery in the euro area and the ECB’s rate-cutting cycle. Starting in June, we foresee the ECB cutting its deposit rate by 100 bps by year’s end. We therefore believe that spread widening will be more limited for euro IG than for its US equivalent.

While we remain somewhat concerned about tight IG spreads, we have to admit that US and euro IG corporate bond yields are still at historically attractive levels. However, after the relentless spread tightening of recent months, these elevated yields are mostly due to high policy rates. In anticipation of central bank rate cuts, this is helping validate our investment theme ‘From cash to duration’, which aims to lock in the elevated yields offered by quality corporate issuers.

Euro IG should continue to outperform cash this year given our expectations for 100 bps of cuts to the ECB’s deposit rate. By contrast, the delay in Fed rate cuts means that cash in US dollars will likely continue to offer juicy returns, while high valuations point to widening of US IG spreads. As such, while we remain overweight euro IG credits, we have moved from overweight to neutral on US IG.