Corporate bonds: 2024 Outlook

With the fast increase in policy rates over the last 18 months threatening growth prospects and pushing up sovereign bond yields, our favourite investment theme in fixed income has been short-term IG corporate bonds. As we believe that fixed income overall now offers better risk-adjusted return prospects than equities as yields peak, we have moved to an overweight position in euro IG credit, in line with our overweighting of US IG. And as cash becomes less attractive in anticipation of central bank rate cuts next year, we have been pushing to lengthen our duration exposure to IG credit. As we believe 10-year US Treasury yields have more limited downside than 10-year German Bund yields, we favour US IG corporate bonds of up to five years maturity, but up to seven years in euro IG.

In short, we continue to favour locking in the high yields offered currently by companies of quality. We see cash as looking less attractive as short-term yields increasingly price in cuts to policy rates over the coming year.

We still prefer the highest-quality bonds as we believe HY bonds are not adequately rewarding investors for the level of risk they involve. The difference in spreads between BB-rated and BBB-rated issues in both the US and euro area is below historical median levels, which suggests to us that investors are not being adequately rewarded for taking on the level of risk associated with HY relative to IG.  With refinancing costs high and default rates rising, we only expect a low single-digit total return for US and euro HY next year, whereas we expect a mid-to-high single-digit total return for US and euro IG.