Capital Ideas^TM

Corporate bond markets delivered positive excess returns for the quarter, despite some investor caution around a pullback in expectations for interest rate cuts, which led to some volatility in government bond yields. That said, this masked some regional divergence with European corporates underperforming their US counterparts due to political events in Europe. France’s President Emmanuel Macron called a snap parliamentary election after a difficult European election which saw a surge in support for the far right. Issuance, which had been heavy in the first quarter and readily taken up by the market, fell back in the second quarter given market volatility.

Credit spreads widened modestly over the quarter. The yield spread over government bonds for the corporate bond index (Bloomberg Global Aggregate Corporate Index) closed June at 104 basis points (bps), marginally wider (by 4 bps) versus levels at the end of March. In terms of regional spreads, European corporate bonds widened by 6 bps to finish the quarter at 120 bps, whereas US corporates widened by 4 bps to finish the quarter at 94 bps. Therefore, the additional spread offered by European corporates over US corporates widened slightly (by 2 bps) to end the quarter at 26 bps. 

Corporate bond spreads

Data as at 28 June 2024. IG: investment grade, OAS: option adjusted spread. Indices: Bloomberg Euro Aggregate Corporate Index, Bloomberg US Corporate Investment Grade Index, Bloomberg Global Aggregate Corporate Index. Source: Bloomberg

The outlook for the global economic, geopolitical and monetary policy environment remains uncertain. The potential for recession and weakening corporate fundamentals is still present, despite the improvement in financial market conditions over the past year. At an index level, valuations are not compelling overall, as corporate credit spreads are somewhat tight versus historical averages. However, there are pockets of opportunities, such as on a regional level given wider spreads in European corporate bonds versus their US counterparts, and on a sector level given better valuations in financials than industrials.

Demand for corporate bonds from investors remains solid and recent issuance has been taken up well. The all-in yield of global corporate bonds remains reasonably attractive, and the opportunity to secure today’s yield levels may not be sustained for long given expectations for interest rates to fall. Due to the uncertainties mentioned, we are not positioned in global corporate bond portfolios for one particular macroeconomic outcome. Instead, our focus is on finding idiosyncratic opportunities on the company and sector level such as in banking, pharmaceuticals and utilities.