Fixed income has struggled thus far in 2018, with the Bloomberg Barclays U.S. aggregate down 1.6% year-to-date. But in this period of rising interest rates, not all fixed income is responding uniformly. U.S. investment grade (IG) corporates are a prime example of this, having returned -3.2% on a total return basis, its worst six month return since the summer of 2015. This poor performance makes U.S. IG fixed income the worst performing sector of the U.S. bond market so far this year.
So what is driving this underperformance in U.S. IG? The below chart highlights two apparent issues. First, the duration of U.S IG debt has reached a record high of 7.5 years, as companies have issued debt at increasingly longer maturities in the face of persistently lower interest rates. In an environment where the Fed is tightening monetary policy, high duration sectors like U.S. IG have fallen out of favor, resulting in a rotation toward safety elsewhere. Second, the credit rating of the U.S. IG universe has deteriorated over time, resulting in the asset class becoming more risky: as a percentage of the benchmark, BBB bonds, the lowest rating that qualifies as investment grade, has risen from 35% in 2007 to 48% in May 2018. As we enter the later stages of the expansion, investors will likely continue to have an unfavorable view of lower quality bonds.
With the Fed continuing to tighten monetary policy and the economy now solidly late-cycle, investors will need to continue being selective within fixed income. In our view, there are better risk-reward opportunities in shorter duration credit and Treasury markets for U.S.-based investors.
U.S. Investment Grade – credit rating and duration
Source: Bloomberg, FactSet, J.P. Morgan Asset Management. Data are as of June 28th, 2018.