Investment Grade Credit’s Rebound Signals Opportunity Into 2024

Look for the investment grade credit market’s golden November glow to continue through year-end 2023 and into 2024.

Reversing October’s doldrums were supportive news on technicals early in November, with indications of lower-than-expected long-end issuance, and mid-month reports of surprisingly good fundamentals: retail prices didn’t rise, and wholesale prices showed their biggest decline in three-and-a-half years. This is after October saw higher-than-expected inflation, worries about even higher interest rates, and largely negative excess returns across the board.

November’s slowdown in inflation, coupled with a cooler labor-market report that indicated somewhat higher unemployment and fewer job openings, point to a softer tone from the Federal Reserve in the near term. That more hopeful outlook contributed to a strong rebound, with performance that more than made up for October’s negative excess returns.

One indication of fundamental strength is the continuing favorable ratio of rising stars to fallen angels (companies moving from spec-grade to investment grade, and vice versa), including a large auto manufacturer as a notable recent riser, which added about 55 basis points to the investment grade (IG) index.1 While one could argue that the return of fallen angels to the IG realm represents a snapback from Covid, the phenomenon is nevertheless real and positive.

Rising Stars Have Significantly Exceeded Fallen Angels Since Mid-2021

Source: BofA Global Research as of 31 October 2023.

In terms of valuations, spreads are well through their long-term averages, but all-in yields of about 6% are capturing investors’ attention.

Investors Are Taking Note of US Credit Yields

Source: Bloomberg, PineBridge Investments as of 27 November 2023.

Demand has created strong bids at the long end of the market, where a dearth of supply – which is down about 20% year-over-year for bonds maturing in 10 or more years2 – is driven in large part by investors’ belief that rates will go lower and by holders who are unwilling to sell at a loss. Those conditions will likely persist, but if more investors come to believe that the curve will steepen, we’re likely to see greater interest in the five- to 10-year area.

The credit curve is unlikely to steepen meaningfully until rates start to move lower. Investors will then focus on buying more intermediate maturities, and issuers will be more willing to issue long term. Until then, technicals remain strong and domestic demand from traditional investors, notably pensions, is holding firm. All that bodes well for a year-end rally and for attractive buying opportunities to present themselves over the next few months.

While it’s always possible that some major unexpected change in employment or inflation could rile markets in the short term, the chief risk to our generally positive scenario is that the Federal Reserve maintains interest rates at their current high levels, which would weaken the economy and lend greater weakness to credit. That said, the likelihood of another significant selloff, with spreads hitting the 145 to 147 levels of earlier this year, seems remote.

Signs point to a continuation of recent supportive trends, and we maintain our positive outlook for US dollar investment grade credit.