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Corporate Credit Update

US

Investment-grade corporate credit risk continued to cool Tuesday, little off early session lows, risk back to mid-September levels as were stocks as rates rallied post-PPI, underscoring year-end step-down pricing (50bp hike vs. 75bp).

  • Investment grade risk measured by Markit's CDXIG5 index is currently -1.831 at 81.551; CDXHY5 high yield index 100.827 (+0.490).
  • Outperforming credit sectors (tighter or least wide): Communications (-5.9), Consumer Staples (-5.2), Sr Financials (-4.8).
  • Lagging sectors (wider or least narrow): Utilities (-3.4), Industrials (-3.5) and Health Care (-3.8).

Global Credit: Maximizing portfolio returns for 2023
2023 has the potential to be an outstanding year for investors, but timing asset allocation shifts will differentiate the winners. In 1H, investors should favor European and UK credit risk and US duration risk ahead of an expected April recession, but be prepared to rotate into US credit risk as we approach mid-year. For the full year, we see the best excess return opportunities in EU HY/LL at 9/11% and UK IG at 5%. But we think the best total return potential lies in fixed rate bonds: UK/US IG at 15/14% and EU/US HY at 15/14%, respectively. We recommend three top macro credit trades for the year: 1) Long European vs. US high yield 2) Long US investment grade over leveraged loans; 3) Long US low coupon MBS.

US Credit: Investing for a US recession and beyond
In the US we see a tale of two halves: a challenging 1H with a Fed pause in Q1 at ~5% followed by a recession starting in April (‘23E real GDP -0.9%), exposing US LL vulnerabilities with CCC CLO exposures rising to ~15% and LL/HY defaults rising to ~9/6.5%. We expect IG/HY/LL spreads widen materially to 210/750/900bp in Q2. Stress will be higher in LL tech/healthcare/consumer and HY telecoms/transports/consumer. However, by mid-year falling inflation (’23E PCE inflation 1.7%), a reactive Fed (Fed Funds at 3% by end-23E), and more resilient IG/HY balance sheets support a recovery and IG/HY/LL spreads should finish at 150/525/625bp. We expect the mid-year rotation into HY to be supported by primary markets, with IG/HY/LL supply of +5/+105/-18% y/y, respectively. For FY23 we forecast IG/HY/LL excess and total returns of 1/3/2% and 14/14/6%, respectively.
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