Opinions, estimates, forecasts, projections and statements of financial market trends are based on market conditions at the date of the publication, constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.
24 March 2023
Where to position now in IG credit
The quick resolution to issues with a global systemically important bank in Europe, and the swift action from the Federal Reserve and US government to stem a regional banking crisis, are significant events in market history. We evaluate the impact that these recent events could have on investment grade (IG) credit spreads and the risk of a recession.
Fundamentals
Market volatility has remained high, as concerns over the US banking crisis have spilled into Europe, and as the impact of aggressive policy rate hikes from central banks have become clearer. This volatility is in stark contrast to the start of the year, when markets were lifted by a string of strong data surprises that appeared to push the risk of a recession into 2024. However, the repercussions of Silicon Valley Bank’s collapse have sparked a reversal in market sentiment. Although the market facilities introduced by the Federal Reserve and the US government should, in theory, calm markets, investors should not expect a quick return to where we were before. Not least because the banks would be expected to strengthen their balance sheets in reaction to recent events. As banks de-risk, it is likely that we will see a drop in lending activity, which could ultimately lead to a further tightening of credit conditions and bring forward a recession.
Quantitative valuations
Spread widening on the back of recent market volatility saw US IG spreads reach a peak of 164 basis points (bps) on 16 March, which is the widest we’ve since since 21 October 2022. At the same time, developed market government bond yields provided protection, with US 10-year Treasury yields rallying 51bps from 28 February to 3.40% on 17 March. Interestingly, for the time being, the panic appears to have abated and spreads have retraced around 30%-40% from their recent highs. As of 21 March, US IG credit spreads were at 145bps. At this level, we find that spreads are pricing in a 33% chance of a recession in the US. That said, if we see a material tightening in credit conditions, we’d expect to see spreads widen further as the markets move to price in a recession sooner rather than later.
US investment grade credit spreads are only pricing in a 33% chance of recession
Source: Bloomberg, J.P. Morgan Asset Management; data as of 22 March 2023.
Technicals
The technical backdrop for high quality bonds has recently been positive. Risk-off sentiment has pushed investors into high quality government bonds and money market mutual funds. US and European government bond funds and exchange-traded funds have received over USD 18 billion of inflows month to date (as of 21 March 2023). Furthermore, recent investor positioning surveys show investors are adding duration across developed markets. As credit conditions tighten and the probability of a recession increases, we’d expect to see further moves into fixed income as investors look to add duration.
What does this mean for fixed income investors?
In our latest Investment Quarterly meeting, recession remained our base case view, with a 60% probability. We think recent events will lead to a tightening in credit conditions, which in the end could bring a recession forward. At the moment, with IG credit spreads only pricing in a 33% chance of a recession over the next year, we’d expect to see further widening in spreads as the market starts to price in a downturn. Across our portfolios we prefer to be long duration and higher quality within investment grade credit.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum
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