Why credit in 2024?

Change in direction for inflation and rates

One of the biggest changes since mid-2023 is the outlook for inflation and interest rates. In the US and Europe, inflation has come down towards the central banks’ 2% targets, prompting surprisingly dovish pivots from the Federal Reserve (Fed) and the European Central Bank (ECB).

Historically, as central banks begin to cut rates, credit spreads have exhibited greater dispersion in month-over-month changes, compared to hiking cycles or periods of rate stability. This volatility should offer active managers opportunities for excess returns at a time when corporate fundamentals appear robust.

Exhibit 1: Monthly US IG spread changes during different Fed actions

Monthly Spread Change Split by Fed Action

^{Source:  Bloomberg Barclays. As of 11/30/2023.}

Corporate fundamentals are holding up

Global IG company fundamentals remain solid against the shifting macro backdrop. The combination of moderate growth, slowing inflation and central bank easing bias creates a very different macro backdrop from recent years and, in our view, a powerful tailwind to bond markets.

In the US, median industrial revenue growth continued to slow in 3Q 2023 yet earnings growth ticked up vs. the prior quarter. Gross debt growth remains flat while both gross and net leverage have stabilised at pre-Covid levels.

Even in the most conservative scenario of a recession, we expect earnings for many sectors in the US IG space converge to around flat growth. However, in our base-case scenario of a soft-landing, earnings are expected to be positive in all but one sector (autos) across the time frame.

Exhibit 2: Next 12 months earnings estimates by sector under a recession scenario

"Recession" Case EBITDA T12m estimates by sector

^{Source: J.P. Morgan Asset Management, median IG industrial company. Median data as of 31/09/2023, forecasts through 31/09/2024. *Estimates (Q423 –Q324). EBITDA = earnings before interest, taxes, depreciation and amortisation. Past performance is not a reliable indicator of current and future results.}

In Europe, we expect revenues to stabilise through the middle of 2024. Balance sheets generally remain robust with leverage at the low end of historical ranges, and management teams have generally been disciplined in capital allocation, with an emphasis on strong liquidity and ratings stability.

The US banking sector has stabilised after a challenging start to 2023. Earnings power is offsetting elevated losses from office commercial real estate exposure, and regional banks have been attracting deposits. Deposit trends in Europe show greater stickiness and improved pre-provision operating profit means comfortable headroom to absorb the higher cost of risk.

Technical support remains strong

Supply and demand dynamics for IG bonds should be supportive in 2024. Retail demand in the US tends to correlate with positive returns and this should persist throughout the year. On the supply side, we anticipate around $275 billion of net US issuance in 2024 – shaping up for perhaps the lowest net supply growth year on year since 2019.

How tight is tight?

While we believe fundamentals and technicals for the asset class remain robust, we recognise there is less conviction from a valuation perspective.

Putting current spread levels in context, we analysed how frequently the US IG index has traded at similarly tight levels. Since 2001, the index has spent a third of trading days inside 110bps and almost a quarter of time inside 100bps (US spread levels were 99bps as at 29 Dec 2023). Additional analysis showed that spreads wider than 110bps offered a consistently higher probability of achieving a positive excess return but when there was a negative excess return, the drawdown was more severe.

Exhibit 3: Percentage of trading days US IG index has traded at various spread ranges since 2001

The US IG Index has spent 33% of trading days inside 110bps since 2001

^{Source: Bloomberg Barclays; Spread Data uses US IG Corporate Index daily data. As of 12/6/2023.}

Pockets of value in IG

Despite this overall tighter spread environment, we continue to find pockets of value across the IG universe. All-in yields in the long end of the US IG corporate curve look attractive against historical levels. We expect the corporate spread curve to flatten as the US Treasury curve steepens to more normal levels.

Exhibit 4: Percentile of attractiveness of the long end of US IG corporate yield

Percentile of attractiveness of the long end of US IG corporate yield

^{Source: Bloomberg Barclays; Spread Data as of 12/11/2023.}

European IG credit spreads still trade wide compared to US IG spreads (138bps vs 99bps at end-2023) and we also find European IG senior and non-financial subordinated debt (hybrids) attractive. For hybrids, outright spreads and senior subordinated multiples are cheap in our view and offer upside.

Exhibit 5: European IG and non-financial hybrid option-adjusted spread

European Credit € Investment Grade & Non-Financial € Hybrid OAS (IG +HY)

^{Source: Bloomberg Barclays; Spread Data as of 12/11/2023.}

Lastly, we find additional tier one capital (AT1) debt attractive, particularly from European banks. Spreads are still wide to recent tights and new deals have been performing well.

What does this mean for fixed income investors?

Spreads are currently pricing in a relatively low probability of recession but we expect increased volatility as markets navigate the directional change in monetary policy. We believe that active managers can look for opportunities to add to positions in these periods of volatility and we highlight current value in areas such as the long end of the US IG corporate curve and European investment grade hybrids.

With central banks likely to begin easing and yields moving lower, all-in yields look attractive and it remains an opportune time for investors to buy credit.

For regular insights on fixed income from J.P.Morgan Asset Management, visit the Fixed income insights page.

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This is a marketing communication and as such the views contained herein are not to be taken as advice or a recommendation. The value of investments and the income from them may fluctuate in accordance with market conditions and investors may not get back the full amount invested. Past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast made will come to pass. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued in the UK by JPMorgan Asset Management (UK) Limited, which is authorised and regulated by the Financial Conduct Authority.